A Summary of Comparing Cost and Revenue To Maximize Profit

A SUMMARY OF COMPARING COST AND REVENUE TO MAXIMIZE PROFIT
WHAT IS REVENUE?
- Revenue is the total amount of money received by the company for goods and
sold and services provided during a certain time period.
WHAT IS COST?
- Is the value of money that has been used up to produced something or delivers a
service, and hence is not available for use anymore.
MAXIMIZE PROFIT
- In economics, profit maximization is the short run or long run process by which a
firm may determine the price, input and output levels that will lead to the highest
possible total profit.
How Perfectly Competitive Firms Make Output Decisions

A perfectly competitive firm has only one major decision to make—namely, what
quantity to produce. To understand why this is so, consider the basic definition of profit:
Profit=Total revenue−Total cost

=(Price)(Quantity produced) ─ (Average cost)(Quantity produced)
Since a perfectly competitive firm must accept the price for its output as determined
by the product’s market demand and supply, it cannot choose the price it charges. Rather, the
perfectly competitive firm can choose to sell any quantity of output at exactly the same price.
This implies that the firm faces a perfectly elastic demand curve for its product: buyers are
willing to buy any number of units of output from the firm at the market price. When the
perfectly competitive firm chooses what quantity to produce, then this quantity—along with
the prices prevailing in the market for output and inputs—will determine the firm’s total
revenue, total costs, and ultimately, level of profits.
Determining the Highest Profit by Comparing Total Revenue and Total Cost
A perfectly competitive firm can sell as large a quantity as it wishes, as long as it accepts the
prevailing market price. Total revenue is going to increase as the firm sells more, depending
on the price of the product and the number of units sold. If you increase the number of units
sold at a given price, then total revenue will increase. If the price of the product increases for
every unit sold, then total revenue also increases.
As an example of how a perfectly competitive firm decides what quantity to produce,

consider the case of a small farmer who produces raspberries and sells them frozen for $4 per
pack. Sales of one pack of raspberries will bring in $4, two packs will be $8, and three packs
will be $12, and so on. If, for example, the price of frozen raspberries doubles to $8 per pack,
then sales of one pack of raspberries will be $8, two packs will be $16; three packs will be
$24, and so on.
Total revenue and total costs for the raspberry farm are shown in Table 1 and also appear in
Figure 1.
Table.1 Total Revenue, Total Cost, and Profit at the Raspberry Farm
QUANTITY TOTAL REVENUE TOTAL COST PROFIT
(Q) (TR) (TC) (P)
0 $0 $62 -$62
10 $40 $90 -$50
20 $80 $110 -$30
30 $120 $126 -$6
40 $160 $138 $22
50 $200 $150 $50
60 $240 $165 $75
70 $280 $190 $90
80 $320 $230 $90
90 $360 $296 $64
100 $400 $400 $0
110 $440 $550 $-110
120 $480 $715 $-235
In Figure 1, the horizontal axis shows the quantity of frozen raspberries produced. The
vertical axis shows both total revenue and total costs, measured in dollars. The total cost
curve intersects with the vertical axis at a value that shows the level of fixed costs, and then
slopes upward, first at a decreasing rate, then at an increasing rate. In other words, the cost
curves for a perfectly competitive firm have the same characteristics as the curves that we
covered in the previous module on production and costs.
If the raspberry farmer in figure 1 decides not to produce at all but not exist the market , cost
will be roughly just under $100.
Figure 1: Total Revenue, Total Cost and Profit at the Raspberry Farm. 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 vertical
gap between total revenue and total cost is profit, for example, at Q = 60, TR = 240 and TC =
165. The difference is 75, which is the height of the profit curve at that output level. The firm
doesn’t make a profit at every level of output. 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 100, total revenues exceed total costs,
so the firm is earning profits. However, at any output greater than 100, total costs again
exceed total revenues and the firm is making increasing losses. Total profits appear in the
final column of Table 1. Maximum profit occurs at an output between 70 and 80, when profit
equals $90.
Suppose the raspberry producer’s “fixed” cost increases. What would the cost curve in Figure
1 look like now?
The total cost curve would maintain its curvature but would shift up by the amount of the
fixed cost.
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.

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A SUMMARY OF COMPARING COST AND REVENUE TO MAXIMIZE PROFIT

How Perfectly Competitive Firms Make Output Decisions

Profit=Total revenue−Total cost

As an example of how a perfectly competitive firm decides what quantity to produce,

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