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Chapter 14

Chapter 14. Profit maximisation and output determination. To begin with … 14.1 Objectives of private enterprises 14.2 Determination of profit- maximising output 14.3 Marginal cost schedule = Supply schedule. To begin with …. We have learned that:

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Chapter 14

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  1. Chapter 14 Profit maximisationand output determination To begin with … 14.1 Objectives of private enterprises 14.2 Determination of profit-maximising output 14.3 Marginal cost schedule = Supply schedule

  2. To begin with … • We have learned that: • Public enterprises aim to serve societyby providing public services at low prices. • Private enterprises aim to maximise profits. Do private enterprises have other objectives? How do they decide on the amount of their output to maximise their profit?

  3. Task 14.1 Benjamin runs a bakery. He is facing some problems in his business and is thinking of the ways to deal with them. Earn more profit to buy a diamond ring Enlarge customer base to expand my business Livelihood of the cashier Want the poor to enjoy my bread and cakes

  4. Task 14.1 If you were Benjamin, what would you do? Answers will be provided in the final version. Earn more profit to buy a diamond ring Enlarge customer base to expand my business Livelihood of the cashier Want the poor to enjoy my bread and cakes

  5. 14.1Objectives of private enterprises

  6. 14.1 Objectives of private enterprises Objectives of private enterprises Provision of non-profitmaking goods and services Market share maximisation Profit maximisation Corporate social responsibility

  7. A. Profit maximisation • Profit is the net receipts of a firm or the return from entrepreneurship. – Profit = Total revenue (TR) Total cost (TC) Entrepreneurs maximise their profits in order to satisfy as many of their wants as possible. Economists assume that profit maximisation is the major objective of most surviving private enterprises.

  8. B. Market share maximisation The market share of a firm in a particular industry refers to the percentage of the firm’s product sales to the industry’s product sales. Product sales can be measured by: 1. Sales revenue 2. Sales volume $ $ $ $ $ $ $ $ $ $ $

  9. B. Market share maximisation • Market share = 1. Sales revenue 2. Sales volume Market share = $ Firm’s sales revenue Firm’s sales volume $ $ $ Industry’s total sales volume Industry’s total sales revenue $ $ $ $ $ $ $ More common

  10. B. Market share maximisation • Is their understanding of market share the same? We’ve the largest marketsharebecause our salesrevenue is the largest inthe market! We’ve the largestmarketshare because our salesvolume is the largest inthe market! Answers will be provided in the final version.

  11. B. Market share maximisation • Why do some firms aim to maximise their market shares? Maximise market share Become dominant in the market Have greater market power Earn more profit later The largest market share may NOT bring the firm the largest profit.

  12. B. Market share maximisation • Must market share maximisation be consistent with profit maximisation? Why do some dot-com companies try to maximise their market share even if they suffer great losses as a result? Answers will be provided in the final version.

  13. C. Corporate social responsibility • Corporate social responsibility refers to the responsibility of a firm to society and all its stakeholders. Who are the stakeholders? People who affect or are affected by the decisions and behaviour of the firm. Which of the following parties can be stakeholders of a firm? d. The government a.Shareholders e. The community b. Customers f. Employees c. Suppliers

  14. C. Corporate social responsibility • Why does a firm take up social responsibility? • Establish goodwill • Attract customers, employees and investors • Promote business growth

  15. C. Corporate social responsibility • Examples of social responsibilityinclude: • Obeying the laws set by the government • Treating and paying their employees fairly • Being trustworthy enterprises to their customers and trading partners • Protecting the environment as well as conserving energy and resources

  16. Economics at work 14.1Examples of corporate social responsibility • 1. The Hongkong & Shanghai Banking Corporation (HSBC)  Scholarship  Business Environment Council  The HKCSS – HSBC Social Enterprise Business Centre  The HSBC Volunteers Scheme Fig. 14.3 Kindergarten subsidised by the HSBC

  17. Economics at work 14.1Examples of corporate social responsibility • 2. Sun Hung Kai Properties (SHKP)  Has issued sustainability reports since 2011  Spent nearly HK$100 million on designing and constructing City Art Square in Sha Tin  Has organised social, cultural and welfare activities for its employees Fig. 14.4 City Art Square designed and constructed by SHKP Charitable Fund

  18. D. Provision of non-profitmaking goods and services • Some private firms provide goods or services to serve the needs of targeted groups for non-profitmaking purposes. b. Tung Wah Group of Hospitals provides medical services to serve low-income earners. a. Breakthrough runs Youth Village for youths.

  19. Economics at work 14.2Social enterprises in Hong Kong • In Hong Kong, social enterprise is defined as a business which aims to achieve specific social objectives. ‘Enhancing Self-Reliance Through District Partnership Programme’ supports the development of social enterprises. Fig. 14.6 A cafeteria operated by Richmond Fellowship of Hong Kong

  20. Go further 14.1Why is profit maximisation assumed to be the major objective of most private enterprises? • Profits are the major source of capital for private firms to survive and develop. If a firm is not maximising its profits:  it may have fewer source of capital;  its growth will be hindered;  it will more likely be beaten down. Thus, we assume that the major objective of most surviving private firms is: Profitmaximisation

  21. Discuss 14.1 • Suppose Benjamin in ‘Task 14.1’ decides to maximise his bakery’s profits. What should be done to maximise his profits? Answers will be provided in the final version.

  22. 14.2 Determination of profit-maximising output

  23. 14.2 Determination of profit-maximising output • In a price-taking market, individual sellers cannot influence the price (P). • They must sell at the same market price. • But they can choose their quantities supplied (Q). • The output at which a firm can maximise its profit is called the profit-maximising output.

  24. 14.2 Determination ofprofit-maximising output • Two approaches to determine the profit-maximising output: • A. Total revenue and total cost approach • B. Marginal revenue and marginal cost approach

  25. A. Total revenue and total cost approach • This approach uses total revenue (TR) and total cost (TC) to find the profit-maximising output. • Definitions • a. TR = P × Q • b. TC = The cost of producing a given quantity of output • c. Total profit = TR – TC • Condition for profit maximisation A firm produces output at a point where the difference between total revenue and total cost is the greatest.

  26. A. Total revenue and total cost approach • 3. Example Price-taking: Sell at the market price ($8)

  27. A. Total revenue and total cost approach • 3. Example

  28. A. Total revenue and total cost approach • 3. Example 0 – 1 = -1 8 – 3 = 5 16 – 7 = 9 24 – 13 = 11 32 – 21 = 11 40 – 31 = 9 48 – 43 = 5

  29. A. Total revenue and total cost approach • 3. Example 0 – 1 = -1 The largest 8 – 3 = 5 16 – 7 = 9 24 – 13 = 11 32 – 21 = 11 40 – 31 = 9 48 – 43 = 5 Profit-maximising output

  30. A. Total revenue and total cost approach • 3. Example Why not this one?(To be discussed later) 0 – 1 = -1 The largest 8 – 3 = 5 16 – 7 = 9 24 – 13 = 11 32 – 21 = 11 40 – 31 = 9 48 – 43 = 5 Profit-maximising output

  31. A. Total revenue and total cost approach • 3. Example 0 – 1 = -1 8 – 3 = 5 Total fixed cost 16 – 7 = 9 24 – 13 = 11 32 – 21 = 11 40 – 31 = 9 48 – 43 = 5

  32. Task 14.2 The total monthly profit at Benjamin’s bakery is $12,000 and its monthly rent is $2,000. The owner knows that the market price of bread is $8 and that he can sell all his bread (6,000 units per month) at that price. 1. If the cost of producing an additional unit of bread is $6, should Benjamin produce it? Why? Answers will be provided in the final version.

  33. Task 14.2 The total monthly profit at Benjamin’s bakery is $12,000 and its monthly rent is $2,000. The owner knows that the market price of bread is $8 and that he can sell all his bread (6,000 units per month) at that price. 2. If the cost of producing an additional unit of bread is $10, should Benjamin produce it? Why? Answers will be provided in the final version.

  34. Task 14.2 The total monthly profit at Benjamin’s bakery is $12,000 and its monthly rent is $2,000. The owner knows that the market price of bread is $8 and that he can sell all his bread (6,000 units per month) at that price. 3. If the monthly rent was $20,000 (instead of $2,000), other things being constant, should he decrease or increase the amount of bread he produces? Why?(Hint: Think of how he would make the decision in the short run and long run.) Answers will be provided in the final version.

  35. B. Marginal revenue and marginal cost approach • This approach uses marginal revenue (MR) and marginal cost (MC) to find the firm’s profit-maximising output. • Definitions • a. – MR of nth unit = TR of n units TR of (n-1) units TRn – TR(n-1) = MRn 8 – 0 = 8 = Price 16 – 8 = 8

  36. B. Marginal revenue and marginal cost approach • Definitions • b. – MC of nth unit = TC of n units TC of (n-1) units TCn – TC(n-1) = MCn 3 – 0 = 3 7 – 3 = 4

  37. B. Marginal revenue and marginal cost approach • Definitions • c. Total profit of nunits Total profit of (n-1)units Marginal profit of nthunit – = MR of nthunit – = MC of nth unit 8 – 3 = 5 8 – 4 = 4

  38. B. Marginal revenue and marginal cost approach • 2. Profit-maximising condition Profit is maximised Marginal profit > 0 Marginal profit < 0 Marginal profit = 0 All units with marginal profit > 0 are produced. A firm can increase profit by cutting production of that unit of output. A firm can increase profit by producing that unit of output. No units with marginal profit < 0 are produced.

  39. 3. Finding profit-maximising output by marginal revenue and marginal cost approach Two approaches show the same profit-maximising output. Profit-maximising output Largest total profit MR = MC Marginal profit = 0

  40. 3. Finding profit-maximising output by marginal revenue and marginal cost approach The MR and MC approach can be illustrated by a graph. P MC 8 P = MR MR = MC Q 0 4 4 8 8 Profit-maximising output

  41. 3. Finding profit-maximising output by marginal revenue and marginal cost approach Two approaches show the same total profit. Total profit at 4 units of output = Profit at zero output + Sum of marginal profit = -$1 + ($6 + $4 + $2 + $0) = $11 = TR – TC

  42. Learning tips 14.1 Which one is the profit-maximising output? • Produce 3 units or 4 units of output? • Marginal profit of the 4th unit is $0. • Production of that unit does not affect the total profit. • Production of that unit can enlarge the market share. • Therefore, economists suggest that the firm produces 4 units.

  43. Discuss 14.2 • Given that a firm earns a positive profit, use the marginal revenue and marginal cost approach to explain why the change in fixed cost cannot affect the firm’s profit-maximising output level. Answers will be provided in the final version.

  44. Test yourself 14.1 • The table on the right shows the marginal cost schedule of Firm A. Suppose this price-taking firm has a fixed cost of $2 and charges a uniform price of $5 (i.e., charges the same price for all units). Complete the table, and find the profit-maximising output and the corresponding profit. Answers will be provided in the final version.

  45. Past exam Q • 1. Refer to the following table showing the production costs of a price-taking firm. If the product price is $6, A. the firm will produce 5 units of output to maximize its profit. B. the maximum profit the firm can make is $5. C. the average variable cost is $5 when the firm maximizes its profit. D. the minimum total cost of the firm is $13. (HKDSE 2012, Q9)

  46. 14.3 Marginal cost schedule • = Supply schedule

  47. 14.3 MC schedule = Supply schedule • A price-taking firm’s marginal cost schedule is actually its supply schedule. When the price is $3, the firm will take and sell at the market price and henceMR = $3.  To maximise profit, the firm will choose to produce at the output where MR = MC. 3 1 Quantity supplied is 1 unit when the price is $3.

  48. 14.3 MC schedule = Supply schedule When the price is $4, MR = MC = $4.  The profit-maximising output is 2 units.  The quantity supplied at $4 is 2 units. 2 4

  49. 14.3 MC schedule = Supply schedule Quantity supplied can be determined by equating MC with price.  Quantity supplied at any given price is actually the quantity on the MC schedule.  Therefore, MC schedule = Supply schedule 2 1 3

  50. Past exam Q • 2. The marginal cost schedule of a firm can be interpreted as its supply schedule in the production of a good because A. marginal cost will increase when the output of the firm increases. B. we can tell the quantity of the good the firm plans to produce from the marginal cost schedule given the price of the good. C. the quantity of the good the firm plans to produce depends positively on the marginal cost of producing the good. D. we can tell the price of the good from the marginal cost schedule given the quantity of the good. (HKDSE Sample Paper, Q8)

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