Reducing Cost and Profit Maximization - Essay Example

Business units are looking for ways to maximize profits. Different ways and techniques are used to ensure that profits maximizes. Human beings in the society act as “both producers and consumers”. (Producers & Profit Maximization, 2010) So, deciding on the output calls for s major decision as the producer needs to decide “what to produce, how much to produce and for whom to produce”. (Producers & Profit Maximization, 2010) While deciding this special efforts are laid to ensure that profit maximizes. Profit maximization is “a process through which the firm ascertain the amount of goods they are going to produce for a particular price which will reap maximum profit for the business unit”. (Producers & Profit Maximization, 2010) Profit maximization thus looks into improvement of the present situation into a better one. This also acts as a mechanism to ensure that “competitors stay out of business”. (Profit Maximization, 2010) In economic terms “profit is the difference between total revenue and total opportunity cost”. (Profit Maximization, 2010) Total revenue is the total earnings. Total opportunity cost is total input cost along with the cost for the next best alternative. Organisations to maximize profits thus need “to lower the opportunity cost”. (Profit Maximization, 2010) This will ensure that profits maximizes for the business. A research conducted on profit maximization shows that “firms maximizes profits when they are able to control the input variables as the cost of input helps to keep the output variable the same thereby reducing cost and maximizing profits”. (Rice, 1995) This is one of the reason we see business units looking for low cost destinations to produce so that the input cost reduces and this will help to maximize returns. Another study shows that “business units to maximize profits need to have multi-products as customers who are impatient and want new products get a range which will ensure that business units are able to sell more and the customer get a variety and profit maximizes”. (Levin, Ma & Wright, 2003) This will also ensure that business units are able to push additional units to the customer thereby making them earn higher revenues. Another study shows that “business units to maximize profits needs to improve their supply chain and look for transfer pricing model so that they are able to extract the best price for it and doing so will ensure that there is timely delivery of goods and services which will ensure the best price”. (Tan & Renato, 2008) This can be understood by the following example by a simple example Total Hours worked per day Lawn mowed per day cost ($11per hour) Revenue($18 per lawn) Profit 8 7 88 126 38 10 9 110 162 52 12 11 132 198 66 14 13 154 234 80 16 15 176 252 76 18 17 198 270 72 20 19 220 288 68 22 21 242 288 46 Here we see that as more and more hours are employed the cost keep on rising but the revenues don’t rise at the same rate as the cost. It is seen in the above example that the profit maximization point is when working for 14 hours. It is at this point that profit is $80 and since then it starts to fall. The organisation should look at performing at this point to ensure that it is able to use the resources wisely. This is the best point to work as “profit is equal to the marginal cost”. (Producers & Profit Maximization, 2010) This can be seen from the following graph Figure 1: Profit Maximization Source: Samuelson, 200, page 47 It is seen that the best point to perform which maximizes profit is “when marginal cost is equal to marginal revenue as this is a point where the organisation is able to yield the best results”. (Samuelson, 2003) This is where every unit wishes to perform so that the returns are the highest and also ensures that resources are not wasted. The marginal cost and marginal revenue model thus shown in the above graph considers the change in output due to change in input. This model thus considers “the average total cost, marginal cost which is change in cost due to additional unit being produced and marginal revenue which is additional revenue due to one more unit sold”. (Profit Maximize, 2010) This thus considers business units from the economic angle and tries to present a better picture for the business unit and also shows the different opportunity available. The marginal cost and marginal revenue concept for profit maximization can be understood from the following example Output Price Total Revenue Marginal Revenue Total Cost Average total cost Marginal Cost Profits 0 14 0   2     -2 1 12 12 12 6 6 4 6 2 10 20 8 8 4 2 12 3 8 24 4 12 4 4 12 4 6 24 0 20 5 8 4 5 4 20 -4 35 7 15 -15 It is seen from the above example that as output increases the total revenue increase but after 4 units of output revenues start to fall. This causes a rise in marginal revenue but after 2 units it starts to fall. The marginal cost also shows similarity. It starts to rise after 3 units. This shows that the business units have same profit of 12 at 2 and 3 units. This will lead the business unit to manufacture 3 units. This is so because the “marginal revenue is equal to marginal cost” (Davies, 2010) at this point. This will also ensure that business units earn additional revenue by producing 3 units. In case they had produced 2 units the revenues would have been less. This might force the business unit to produce more due to the expectation of earning more. This might also make the units produce 4 units as the revenue remains the same. But since the cost associate with it also raises so the firm will not produce 4 units. This will make the business produce 3 units and this thereby ensure that “marginal cost is equal to marginal revenue at this point”. (Davies, 2010) The graph for the above helps to understand it better. It is as follows Figure 2: Profit Maximizing Decision It is seen from the above graph that “the best point for profit maximization is when the marginal cost and marginal revenue equals each other”. (Davies, 2010) It is seen that marginal revenue continues to fall. This supports the findings as shown in the above table. The marginal cost also shows a dip early on but then starts to rise. The demand curve is also downward sloping specifying competition. It also shows that as “prices fall demand rises and when price rises demand falls showing an inverse relation”. (Davies, 2010) This thus, satisfies the condition and also represents that to maximize profits business units need to look at a point where “marginal cost equals to marginal revenue”. (Davies, 2010) This will enable business units to maximize returns. Another way to look at this is to see that “business units continue to produce as long as marginal revenue is greater than marginal cost as it will ensure that business units continue to earn some profits”. (Profit Maximize, 2010) This will ensure that business units need not ascertain the units by changing output and ensure steady production. The problem with using this is that “it won’t give the profit maximization point though business units will earn profit as there will be a scope to increase revenue and this will match when the marginal cost = marginal revenues”. (Profit Maximize, 2010) This thus sees that business units looking for profit maximization move towards this point. Profit maximization thus ensures that business units continue to earn maximum return. Business all around the world is looking to ensure that they maximize their return. For this they ensure that cost is controlled as input is a variable which can be altered. The output price depends on various factors like competition, demand and other variables. So business units are looking towards input. Controlling them will help to ensure that input cost doesn’t rise. Thus, we see that business units all around the world are looking for ways to reduce cost. They are also looking for ways to maximize profits. Thus it is important that business units need to maximize profits and see that the resources are used wisely. This will help to ensure that the efforts are directed in the correct direction and will help to maximize the profit and ensure that growth prevails. References Davies D, 2010, “Profit Maximization”, retrieved on May 3, 2010 from http://www.cliffsnotes.com/study_guide/Profit-Maximization.topicArticleId-9789,articleId-9769.html Levin E, Ma Y & Wright R, 2003, “Profit maximization in a multi product firm with impatient customers”, Journal of the Operational Research Society, Volume 55, page 211-218 Producers & Profit Maximization, 2010, “Producers & Profit Maximization”, retrieved on May 3 2010 from http://arnoldkling.com/econ/markets/producer.html Profit Maximization, 2010, “Profit Maximization”, retrieved on May 3, 2010 from http://economics.illinoisstate.edu/ntskaggs/eco105/readings/profit-max.htm Profit Maximize, 2010, “Profit Maximization”, retrieved on May 3, 2010 from http://www.nowsell.com/marketing-guide/profit-maximization.html Rice D, 1995, “An experimental method for profit maximization”, International Journal of Production Research, Volume 4, Issue 3, page 215-221 Tan M & Renato D, 2008, “A global supply chain profit maximization and transfer pricing model”, Journal of Business Logistics, Volume 12, page 65-87 Samuelson, 2003, “Managerial Economics”, W & Marks, 4th edition, Wiley & sons page 47 Read More