Profit Maximization and Equilibrium of a Firm

Profit in economics can be described as the organization's net income after all costs, including rent, salaries, interest, and other expenses, have been subtracted from the total income. Typically, the firm's cost items include the normal rate of profit.

The difference between entire income and total costs incurred by the business is the profit. In economics, the symbol "" stands for profit. The formula for is TR -TC. The firm's maximum profit can be easily visualized visually in one of two ways:

• Total revenue: Total cost (TR - TC) approach
• Marginal revenue: Marginal cost (MR - MC) approach

Total Cost: Total Revenue Approach

When a business is operating at its greatest profit, it is in balance. Simply put, if the total revenue minus the total cost is at its greatest point at the time the output is generated. The firm is said to be in equilibrium while maximizing profit in this situation. Total revenue, often known as gross revenue, is the sum of all a company's sales-related receipts. It is calculated by multiplying the price per unit by the total volume of sales (or output). Therefore, TR = Q P. Any amount of output results in a constant product price under perfect competition. As a result, the amount of output positively and proportionately affects total revenue. At 450, the TR curve dips uphill and to the right. The sum of total fixed costs and total variable costs represents overall cost in the short term. Total cost follows the trend of total variable cost since total fixed cost is constant and positive at whatever level of output.

Marginal Revenue: Marginal Cost Approach

When businesses are united to examine an industry, it is problematic to utilize the total revenue - total cost technique. The alternative technique, based on marginal cost and marginal income, employs price as an explicit variable and thus demonstrates clearly the behavioral rule that leads to profit maximization.
Selling one additional unit of the output increases the overall revenue, which is known as marginal revenue. To put it another way, it is the proportion of changes in total income to changes in total sales volume (by selling one more unit of output). It displays how quickly total revenue has changed. Thus, MR = ΔTR / ΔQ or MR = TR(n) – TR(n-1)

Marginal cost is the addition made to the total cost by producing one more unit of output. But, the marginal cost in the short run is connected with the variable factor. Thus, the short-run marginal cost is the ratio of the change in the total variable cost of the change in the total quantity produced. It is expressed as MC = ΔTVC / ΔQ.

 In summary:

• If MC < MR, the firm is rewarded for increasing output because the total profit has not been maximized.
• If MC > MR, the level of overall profit declines, making production reductions profitable for the company.
• The short-term gains are highest if MC = MR.

Marginal cost must therefore equal marginal revenue in order for the firm to be in an equilibrium state (MR = MC). This requirement, however, is insufficient because the firm may meet its requirements while still not being in equilibrium. The requirement MC = MR is met at point A in the diagram, however it is obvious that the firm is not in equilibrium because profit maximization occurs at M1 > M. The MC must be increasing at the point where it intersects the MR curve in order for equilibrium to second condition to hold. This implies that the MC must intersect the MR curve below, i.e., the MC's slope must be higher than the MR curve's slope. The slope of the MC is shown in the figure to be positive at B, while the slope of the MR is zero (or negative) at all output levels.

Reference

Koutosoyianis, A (1979), Modern Microeconomics, London Macmillan