Most economists believe that profit maximization promotes [...]
—that resources flow into their highest valued uses.
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Open it Most economists believe that profit maximization promotes allocational efficiency—that resources flow into their highest valued uses.
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3. ANALYSIS OF REVENUE, COSTS, AND PROFITS Total variable cost divided by quantity; (TVC ÷ Q) Average total cost (ATC) Total cost divided by quantity; (TC ÷ Q) or (AFC + AVC) Marginal cost (MC) Change in total cost divided by change in quantity; (∆TC ÷ ∆Q)
<span>3.1. Profit Maximization
In free markets—and even in regulated market economies—profit maximization tends to promote economic welfare and a higher standard of living, and creates wealth for investors. Profit motivates businesses to use resources efficiently and to concentrate on activities in which they have a competitive advantage. Most economists believe that profit maximization promotes allocational efficiency—that resources flow into their highest valued uses.
Overall, the functions of profit are as follows:
Rewards entrepreneurs for risk taking when pursuing business ventures to satisfy consumer demand.
Allocates resources to their most-efficient use; input factors flow from sectors with economic losses to sectors with economic profit, where profit reflects goods most desired by society.
Spurs innovation and the development of new technology.
Stimulates business investment and economic growth.
There are three approaches to calculate the point of profit maximization. First, given that profit is the difference between total revenue and total costs, maximum profit occurs at the output level where this difference is the greatest. Second, maximum profit can also be calculated by comparing revenue and cost for each individual unit of output that is produced and sold. A business increases profit through greater sales as long as per-unit revenue exceeds per-unit cost on the next unit of output sold. Profit maximization takes place at the point where the last individual output unit breaks even. Beyond this point, total profit decreases because the per-unit cost is higher than the per-unit revenue from successive output units. A third approach compares the revenue generated by each resource unit with the cost of that unit. Profit contribution occurs when the revenue from an input unit exceeds its cost. The point of profit maximization is reached when resource units no longer contribute to profit. All three approaches yield the same profit-maximizing quantity of output. (These approaches will be explained in greater detail later.)
Because profit is the difference between revenue and cost, an understanding of profit maximization requires that we examine both of those components. Revenue comes from the demand for the firm’s products, and cost comes from the acquisition and utilization of the firm’s inputs in the production of those products.
3.1.1. Total, Average, and Marginal Revenue
This section briefly examines demand and revenue in preparation for addressing cost. Unless the firm is a pu
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