The per-flight cost consists of variable costs, including jet fuel and pilot salaries, and those are very relevant to the decision about whether to run another flight. However, the per-flight cost also includes expenditures like rental of terminal space, general and administrative costs, and so on.
These costs do not change with an increase in the number of flights, and therefore are irrelevant to that decision. In the real world, it is not so easy to know exactly your Marginal Revenue and Marginal Cost of the last products sold. For example, it is difficult for firms to know the price elasticity of demand for their goods — which determines the MR.
The use of the profit maximization rule also depends on how other firms react. If you increase your price, and other firms may follow, demand may be inelastic.
But, if you are the only firm to increase the price, demand will be elastic. It is difficult to isolate the effect of changing the price on demand. Demand may change due to many other factors apart from price. Increasing prices to maximize profits in the short run could encourage more firms to enter the market. Therefore firms may decide to make less than maximum profits and pursue a higher market share.
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Products conditions really matter in determining the price of the commodity. Figure 1. Total revenue for a perfectly competitive firm is an upward sloping straight line. The slope is equal to the price of the good. Total cost also slopes up, but with some curvature.
At higher levels of output, total cost begins to slope upward more steeply because of diminishing marginal returns. Graphically, profit is the vertical distance between the total revenue curve and the total cost curve. This is shown as the smaller, downward-curving line at the bottom of the graph. The maximum profit will occur at the quantity where the difference between total revenue and total cost is largest.
Based on its total revenue and total cost curves, a perfectly competitive firm like the raspberry farm can calculate the quantity of output that will provide the highest level of profit. At any given quantity, total revenue minus total cost will equal profit. One way to determine the most profitable quantity to produce is to see at what quantity total revenue exceeds total cost by the largest amount. Figure 1 shows total revenue, total cost and profit using the data from Table 1.
The difference is 75, which is the height of the profit curve at that output level. In this example, total costs will exceed total revenues at output levels from 0 to approximately 30, and so over this range of output, the firm will be making losses. At output levels from 40 to , total revenues exceed total costs, so the firm is earning profits. However, at any output greater than , total costs again exceed total revenues and the firm is making increasing losses.
Total profits appear in the final column of Table 1. A higher price would mean that total revenue would be higher for every quantity sold.
Graphically, the total revenue curve would be steeper, reflecting the higher price as the steeper slope. A lower price would flatten the total revenue curve, meaning that total revenue would be lower for every quantity sold. What happens if the price drops low enough so that the total revenue line is completely below the total cost curve; that is, at every level of output, total costs are higher than total revenues?
In this instance, the best the firm can do is to suffer losses. However, a profit-maximizing firm will prefer the quantity of output where total revenues come closest to total costs and thus where the losses are smallest.
The approach that we described in the previous section, using total revenue and total cost, is not the only approach to determining the profit maximizing level of output. In this section, we provide an alternative approach which uses marginal revenue and marginal cost. Firms often do not have the necessary data they need to draw a complete total cost curve for all levels of production.
They cannot be sure of what total costs would look like if they, say, doubled production or cut production in half, because they have not tried it. Restated, MC is infinite where production is maximized. MR would need to be infinite to maximize profit where production is maximized.
Since no one will pay us an infinite price for our product, MC will equal MR at a level of production that is less than maximum production.
Advances in production technology increases output from the same level of variable input. The MC cost is the firm's supply curve for the output. Feel free to use and share this content, but please do so under the conditions of our Creative Commons license and our Rules for Use. Box Fargo, ND Site Manager:.
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