oh, look, I posted it (Chapter 7 Q & A)

23/11/2012 § Leave a comment

#3. Two parter, as always. 25 marks. I don’t know what I expected?

a) At what level of output should a firm produce to maximize its total profits? Use a diagram to help explain your response.

Every firm aims to maximize its total profits, which is something different from revenue. The revenue is the income a firm earns from its sales but they have to use that income to cover the costs it took to produce and sell the goods in the first place. Thus, the leftover money is what we call the profit, therefore profit = TR (total revenue) – TC (total cost). This is what all producers and firms aim to maximize because, well, it’s more money. Firms, in order to maximize their total profit, should always aim to produce at a point where their marginal costs equal their marginal revenue. In the graph below, one shown of a firm in an imperfectly competitive market (identified because the demand curve slopes downwards, which indicates that the firm has some price-making power and the demand is less sensitive to price changes), point A is the point in which MR = MC, and this is where all firms should aim to maximize their total profits. At this point, all their costs are covered by their revenues, which is perfect, actually, and if the firm can keep this up, their business can stay running. Any profit above point A is not normal profit – it is called economic profit (or “supernormal” or “abnormal” profit), which is the typical misconception of what profit is. No, that isn’t the case here. All firms, in order to maximize their profits, should aim to produce at the level of output wherein their MR (marginal revenue) equals their MC (marginal costs).

 

b) ‘Whatever the type of market structure, profit maximization will always be the only goal of firms.’ Discuss.

Typically, all firms will hold the goal of profit maximization – isn’t that the point of running a business? These firms obviously include those in perfect competitions and some in certain imperfect competitions, including oligopolies, and monopolistic competitive firms. These kinds of companies have competition, which means that they aren’t the head honchos in their line of goods and products. Other businesses could easily overtake a single firm if they don’t constantly work to increase their profits and aim to better their goods in the market. I actually don’t know what other goals a firm could have other than earning more profit, but firms that probably won’t hold the goal of profit maximization would be those that are monopolies already. As the big figures of the markets they are already in (I think the airplane-making companies count as monopolies, because there are only two big companies in the world?), they don’t need to worry about making profit maximization their biggest goal because all the money would be going to them anyway. That is the difference between monopolies and the rest of the types of firms – their goals are different because of the amount of competition (or lack thereof).

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