Profit Maximization Firm

Profit

The financial gain a firm or individual earns when the money is received from selling goods or services. It is the financial gain a business earns when its total revenue (TR) exceeds its total cost (TC).

Total Revenue

The total amount of money a firm receives from selling its goods or services at a given price and quantity. It reflects the income before deducting the expenses.

Cost

The value of resources sacrificed (money, time, effort, or materials) to produce a good or service. It represents the expenses a firm must pay in order to operate and bring products to the market.

Total Cost

The overall expense a business incurs in producing a given level of output.

Marginal Analysis

The process of comparing the additional benefits (marginal benefit) and the additional costs (marginal cost) of doing a little more (or a little less) of something.

Implicit Cost

The opportunity cost of using resources that a business already owns, instead of renting, selling, or using them for another purpose.

Explicit Cost

The direct, out-of-pocket payment a business makes to purchase resources or services.

Types of Profit

1. Accounting Profit = TR - Explicit Cost | 2. Economic Profit = TR - (Explicit + Implicit Cost) | 3. Normal Profit = TR = TC | 4. Supernormal Profit = Profit above normal due to efficiency or innovation.

Functions of Profit

1. Reward for risk-taking | 2. Signal of efficiency | 3. Resource allocation | 4. Incentive for innovation

Profits in Different Market Structures

1. Perfect Competition – Normal profit (long run) | 2. Monopoly – Supernormal profit | 3. Oligopoly – Depends on competitors’ strategy | 4. Monopolistic Competition – Short run = abnormal; long run = normal

Total Revenue (TR)

TR = Price × Quantity | Key Points: Depends on price and demand; helps calculate profit, guide pricing and input decisions, determines output.

Total Cost (TC)

TC = TFC + TVC | TFC – Constant (rent, salaries) | TVC – Changes with output (materials, electricity) | Determines profit, guides output/pricing, measures efficiency.

Applications of Marginal Analysis

1. Production | 2. Pricing | 3. Resource allocation | 4. Investment decisions | 5. Healthcare

Shutdown Point

The level of output and price at which a firm is just able to cover its variable costs of production. Below this point, firm stops production in short run. Shutdown ≠ Exit.

Rule of Profit Maximization

Profit is maximized where Marginal Revenue = Marginal Cost. | If MR > MC → Increase output | If MR < MC → Reduce output | If MR = MC → Max profit/min loss

Applications in Health Economics

1. Hospitals – Service mix by revenue vs cost | 2. Pharmaceutical Companies – High prices for patented drugs | 3. Insurance Firms – Maximize premium, minimize payout | 4. Diagnostic Centers – High-margin tests

Positive Effects in Health Economics

1. Encourages efficiency | 2. Drives medical innovation

Negative Effects in Health Economics

1. Reduces accessibility | 2. Causes market failures | 3. Leads to inequality

Government Response

1. Regulation – Price caps, patents, subsidies | 2. Promotion – Non-profit hospitals and universal healthcare

Key Takeaways

Profit-maximizing firms follow MR = MC, but in healthcare this affects lives; governments intervene to balance innovation and equity.