Chapter 9
PROFIT MAXIMIZATION

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1

The Nature of Firms
• A firm is an association of individuals who have organized themselves for the purpose of turning inputs into outputs • Different individuals will provide different types of inputs
– the nature of the contractual relationship between the providers of inputs to a firm may be quite complicated
2

Contractual Relationships
• Some contracts between providers of inputs may be explicit
– may specify hours, work details, or compensation

• Other arrangements will be more implicit in nature
– decision-making authority or sharing of tasks
3

Modeling Firms’ Behavior
• Most economists treat the firm as a single decision-making unit
– the decisions are made by a single dictatorial manager who rationally pursues some goal
• usually profit-maximization

4

Profit Maximization
• A profit-maximizing firm chooses both its inputs and its outputs with the sole goal of achieving maximum economic profits
– seeks to maximize the difference between total revenue and total economic costs

5

Profit Maximization
• If firms are strictly profit maximizers, they will make decisions in a “marginal” way
– examine the marginal profit obtainable from producing one more unit of hiring one additional laborer

6

Output Choice
• Total revenue for a firm is given by
R(q) = p(q)q

• In the production of q, certain economic costs are incurred [C(q)] • Economic profits () are the difference between total revenue and total costs
(q) = R(q) – C(q) = p(q)q –C(q)
7

Output Choice
• The necessary condition for choosing the level of q that maximizes profits can be found by setting the derivative of the  function with respect to q equal to zero d dR dC  ' (q )   0 dq dq dq dR dC  dq dq
8

Output