Introduction

After you have worked through this section of the learning unit, you should be able to:

  • distinguish between profit and profit maximisation

Firms play an important role in helping society to solve the economic problem of scarcity. They are responsible for the production of goods and services that society needs in order to satisfy their needs and wants. Nevertheless, we require more from them than only the production of goods and services – we also require them to make efficient use of resources since our resources are scarce. It is through the payment of profits that an incentive is provided to firms not only to produce those goods and services society need and want, but also to do so in the most efficient way possible.

Profit is simply the difference between total revenue and total cost:

$$\text{Profit } = {\text{total revenue} - \text{total cost}}$$

$$\text{Profit } = {\text{TR} - \text{TC}}$$

Total revenue is the income brought into the firm from selling its products. It is calculated by multiplying the price of the product by the quantity of output sold:

$$\text{Total revenue } = {\text{price} \times \text{quantity}}$$

$$\text{TR } = {\text{P} \times \text{Q}}$$

Which one of the following statements indicates that the profits of BY Construction have increased?

Correct. As long as total revenue rises more than total cost, profits will increase.

Think again. If total revenue rose less than total cost profits decline.  As long as total revenue rises more than total cost, profits will increase.

Think again. If total revenue rose by the same amount as total cost profits are unchanged.  As long as total revenue rises more than total cost, profits will increase.

For firms to survive in a market economy, the bottom line for them is that they should make a profit. Apart from making a profit, they might also have other objectives such as having the largest market share, maximising their sales or revenue or maximising employment. We will assume that they wish not only to make a profit, but also to maximise their profits.

Which one of the following firms do you think is maximising its profits?

Think again. The are maximising employment and not profits.

Think again. This mark-up over cost does not necessarily implies profit maximisation.

Correct. BBC Bakeries is acting in a way that is increasing its profits. It is attempting to ensure that the difference between total revenue and total cost is at a maximum.

Profit maximisation of a firm occurs when the positive difference between total revenue (TR) and total cost (TC) is the greatest. Note that this might not necessarily correspond to the point where total revenue or total employment is at its highest.

Profit maximisation occurs where the positive difference between total revenue (TR) and total cost (TC) is the greatest.

Activity

Now do the following activity to see if you have grasped the concept of profit maximisation:

Profit maximisation occurs _______.

Think again. Profit maximisation not only requires that the total revenue exceeds total costs but positive difference between total revenue and total cost is at its greatest.

Think again. It is only if the mark-up leads to a position where the positive difference between total revenue and total cost is at its greatest that profit maximisation occurs.

Correct. When the positive difference between total revenue and total cost is at its greatest profit maximisation occurs.

You are given the following information about BC Construction. You are asked to advise the company on a number of issues.

Number of houses Total cost Total revenue
500 R26 million R40 million
600 R32 million R48 million
700 R39 million R56 million
800 R48 million R64 million
900 R57 million R72 million
  1. How many houses should BC Construction build to maximise its profits?
  2. If BC Construction wishes to maximise employment opportunities, how many houses should it build?
  3. If BC Construction wishes to maximise revenue, how many houses should it build?
Click to Show Answer

a. 700.

Column 4 indicates the profit, which is the difference between total revenue and total cost. Since maximum profit is where the positive difference between total revenue and total cost is the greatest, the firm should build 700 houses. By building more houses, the firm still makes a profit, but it is not its point of maximum profits.

Number of houses Total cost Total revenue Profits
500 R26 million R40 million R14 million
600 R32 million R48 million R16 million
700 R39 million R56 million R17 million
800 R48 million R64 million R16 million
900 R57 million R72 million R15 million

b. 900

To maximise employment opportunities, BC Construction needs to build 900 houses as this will require the most number of labourers. Note that this does not necessarily correspond to the firm's profit maximisation position, which occurs at 700 houses.

Number of houses Total cost Total revenue Profits
500 R26 million R40 million R14 million
600 R32 million R48 million R16 million
700 R39 million R56 million R17 million
800 R48 million R64 million R16 million
900 R57 million R72 million R15 million

c. 900

To maximise revenue, BC Construction should build 900 houses, since it is for this number of houses that total revenue is the greatest. Note that this does not necessarily correspond to the firm’s profit maximisation position, which occurs at 700 houses.

Number of houses Total cost Total revenue Profits
500 R26 million R40 million R14 million
600 R32 million R48 million R16 million
700 R39 million R56 million R17 million
800 R48 million R64 million R16 million
900 R57 million R72 million R15 million