Video Transcript: Maximizing Profit Under Competition
Hi, welcome back. In this video, we're going to discuss maximizing profit under competition. We all want to know about profit maximization, right? So let's learn about it. Okay, what is profit? Profit equals total revenue minus total cost, right? Our total cash inflows minus our total cash outflows. Right, total revenue equals
price times quantity. So the price that we're selling our product for times the quantity purchased. Right, that's how much revenue we received. Okay, total costs have two parts: fixed cost and a variable cost. So fixed cost would be like your plant, property, and equipment. Let's say we've got a mortgage or a bank note on our plant, and we have to pay that off over time. And our payment is typically fixed, right? When we have a mortgage, it's typically fixed over time, right? So fixed costs are costs that do not vary due to output, right? A lease, most debt payments, etc. Right? Variable costs are costs that do vary with output. So the more we ramp up our production, the higher our variable costs are going to be, right? So when let's say we're operating. Let's say we're producing 100 units in month one, and then in month two we're producing 75 units. Because our output has decreased, our variable cost more than likely will decrease as well. Now, what do I mean by variable costs? Right, electricity costs. Right, if we're not operating as long or as much equipment. Our electricity costs will go down. But if we're ramping up operations, you know we're running overtime. You know our electricity costs are going to go higher. It's variable. It'll change based upon our output. Right. Same thing with transportation costs. We have to ship our products to distributor, right? So, depending on how much output we have, it's going to depend on the transportation cost, right? So, if our output is down, our transportation costs will more than likely be cheaper. If our output is up, it more than likely will be more expensive. Okay, so total cost equal fixed cost plus variable cost, right? Times quantity. Okay, times quantity sold, right? The profit or maximizing quantity when the firm produces an additional unit, there are additional revenues and additional costs. Right. This is we've been talking about this whole entire course about marginal revenue and marginal costs. Right. So every time that we produce an extra unit, right, a marginal unit will receive an additional revenue. Right, so let's say our budget is to sell 100 units, and we sell 101. Obviously, we'll be making additional or marginal revenue. Profit maximization is about comparing the additional revenue from selling an additional unit of output. Okay, you want to make sure that by producing that extra unit is not going to actually hinder us. We don't want to. We want to make sure that the costs to produce that extra unit are never higher than the revenues. Okay, but we do want to see revenues, marginal revenues, equal marginal costs? Then we know that we are meeting our output maximization. Okay. Now marginal revenue again, marginal revenue, the addition to total revenue from selling an additional unit of output. Right. So we have, you know, we we have 100 units sold again 101. That first unit is is considered marginal, right? The the revenue we receive from selling that additional unit is known as
marginal, right? Marginal cost, the addition to total cost from from producing an additional output of labor, so or additional unit of output. So now, if we produce this extra unit, the 101st unit, let's say you know the costs are $5, but the revenues are $6. Do we produce? Yes. Now, do we produce that second unit? Now the costs, the revenues are $5. Now the costs are $5. Now we have marginal revenue equals marginal cost. We should go no further. Now we're maximization of our output. So profits are maximized at the level of output where what marginal revenue equals marginal cost. If marginal revenue. Is greater than marginal cost, you are not profit maximizing. Producing more will add to your profit. So continue to add more, right? So if your revenue is greater than your cost, continue to add more, add more until we get an equilibrium where marginal revenue equals marginal cost. So if our marginal revenue is greater than our marginal cost. Keep adding units. Keep putting more out there. Keep creating more output until we receive that equilibrium: marginal revenue equals marginal cost. If marginal revenue is less than marginal cost, you are not profit maximizing. Producing less will add to your profit. So if our costs are greater than our revenue, we need to back off the production. We need to ramp it and scale it down until we get back to the marginal revenue equals marginal cost level. Right. Therefore, you can only profit maximize if marginal revenue equals marginal cost. Now here's the shape, the shape of a marginal revenue marginal cost curve, right? For a firm in a competitive market, marginal revenue is constant and equal to price because the firm can sell any quantity at the market price, right? So you'll see that 50 is where we're going to be selling at right. That's going to be our maximum profit, as if we're there. Right? Okay. We're selling our goods for $50, and we can sell our goods at $50, no matter the quantity. Okay. So marginal cost rises with production because it gets more costly to produce each additional unit, i.e. or for example, more equipment, more maintenance, more labor. Right. So here you can see that we intersect at at eight units. Right. So here you can see that's where we're going to have our marginal cost equal marginal revenue at that intersection line. So keep building more, keep putting more out, keep manufacturing more until you have your marginal revenue equals marginal cost, as you see here. So maximizing maximizing profit explains behavior, right? As the price goes up, the firm expands production along its marginal cost curve, right? As the price goes up, so does production, right? So here you'll see finally, marginal cost equals marginal revenue at $100 on the world market price.