The traditional view in economics posits that the primary objective of a firm is to maximise its profits. This means achieving the highest possible difference between total revenue (TR) and total cost (TC). This objective drives many of the decisions firms make in the market.
Defining Profit
Profit is calculated as:
Profit = Total Revenue (TR) - Total Cost (TC)
Alternatively, it can be expressed as:
Profit = $\Pi = TR - TC$
Maximising Profit: The Condition
Economically, firms maximise profit where marginal revenue (MR) equals marginal cost (MC). This is a fundamental principle in microeconomics.
Marginal Revenue (MR) is the additional revenue gained from selling one more unit of output.
Marginal Cost (MC) is the additional cost incurred from producing one more unit of output.
The profit-maximising rule is:
$MR = MC$
How Firms Achieve Profit Maximisation
Production Decisions: Firms adjust their level of output to find the quantity where MR = MC.
Pricing Decisions: The profit-maximising output level determines the optimal price at which the firm should sell its goods. The price is typically determined by the demand curve at the profit-maximising quantity.
Input Decisions: Firms also make decisions about the optimal mix of inputs (e.g., labour and capital) to minimise their cost of production.
Graphical Representation
Suggested diagram: A graph showing MC and MR curves intersecting to indicate the profit-maximising quantity of output. The corresponding price is then determined by the demand curve at this quantity.
Limitations of the Profit-Maximising Objective
While the profit-maximising objective is a cornerstone of economic theory, it has limitations:
Short-term vs. Long-term: A firm might sacrifice short-term profits to gain a competitive advantage in the long run (e.g., by investing in research and development).
Social Responsibility: Firms may choose to forgo profit to act in a socially responsible manner (e.g., by reducing pollution or providing employee benefits).
Other Objectives: Some firms may have other objectives besides profit maximisation, such as market share, growth, or customer satisfaction.
Perfect Competition: In perfect competition, firms are price takers and have limited ability to influence price, so profit maximisation is constrained.