Microeconomics: Profit Maximizing Output

Looking for introductory information about profit maximizing output for producers (firms)? Look no further than DiscussEconomics’ microeconomics article section for the latest information on the economy. Let’s begin by asking: How do we know if we have maximized profits or losses?

Decision Rules for Profit-Maximization

Rule #1
Select a quantity where MR (marginal revenue) = MC (marginal cost) and MC “cuts” MR from below.

Using this decision rule, we have three possible profit outcomes:

1. positive (economic) profits
2. break-even (zero economic) profits
3. negative (economic) profits

So then, if a firm experiences losses, should they still produce or shut down operations?

– Think about it, a firm will shut down when the losses associated with a positive output are greater than the losses incurred if they did not produce at all (ie. fixed costs).

– Firms will shut down when profit < – TFC (Total fixed costs)

For a firm to operate it must be that: profit > – TFC

Therefore:

TR (total revenue) – TC (total cost) > -TFC
TR – (TFC + TVC) > -TFC
TR – TFC – TVC > – TFC
TR – TVC = 0
TR > TVC
P/Q x Q > TVC/Q
P/Q > TVC/Q
P > AVC

Rule #2: Only produce output when the price is greater than (or equal to) the average variable cost.

Next article, when to identify the shutdown point for a firm.

2 thoughts on “Microeconomics: Profit Maximizing Output

  1. JMG

    You are suggesting that this type of analysis be used when investigating the health of a potential investment target?

  2. whodat

    In text books when discussing profit maximization the graph shows MR=MC, MC crosses MR from under. The graph usually displays profit as the area between MR and Average total cost. Why is this area considered the profit maximization in texts and not the larger area between MR and MC? I mean the total area to the left where MR=MC.

    THis has been confusing me? Thanks

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