Profit maximization is one of the pillars of economic theory, explaining how companies seek to achieve a high level of profit in order to maximize their wealth and profits, just as individuals do with their level of utility.
This concept is especially important within the microeconomic study, since it is the pillar of multiple economic models. This happens because maximizing the wealth or welfare level is a basic principle that companies follow when facing a certain economic activity. Profit maximization is the economic objective of companies, in order to increase the value of the company. This increase in the value of the company is what shareholders and investors are looking for, who expect their investment in the company to be profitable.
The companies and the different economic agents guide their action decisions towards the objective of achieving the highest possible profit and in this way maximizing their utility and increasing their future consumption possibilities.
In the business world, profit maximization happens by taking into account the level of production of goods or services faced by a certain firm and the costs incurred by it. This production must be directly related to the sale price that you establish and, therefore, the level of income that you will receive when selling these goods or services to the public.
Given these variables, the entrepreneur will act in such a way that the difference between costs and income is as large as possible, so that he maximizes the profit from his activity.
Profit maximization in a monopoly situation
Graphically, the point where the profit of the company is maximized is located where the total income curve and the total cost curve intersect. At this time the difference between income and costs is the maximum possible given the characteristics of a particular company.
Formally, what happens at that point is that the slopes of these curves are equal, so that marginal cost is equal to marginal revenue, there is a so-called optimum point of production.
Marginal Income = Marginal Cost
In other words, from that point on the company is not able to obtain more profit if it increases its production. If it happens that the cost of producing one more unit is greater than the marginal income for that unit, it would be necessary to reduce the level of production as this is excessive, or vice versa.
Profit maximization in a situation of perfect competition
As in a situation of perfect competition, the company is an accepting price, then it sells its product at the price given by the market, so its optimal point will be:
Marginal Cost = Marginal Income = Price
In turn, the demand function is equivalent in the graph to the representation of the price, since at that level it is the only one at which the product can be obtained in this monopoly market.
The profit maximization model offers a very simplified explanation of reality, since usually more subjective variables appear related to the objectives and motivations of their leaders, the absence of perfect information, social work, respect for the environment or scarcity of resources.
The strictest maximization can lead to environmental damage or poor working conditions. For this reason it is considered as a guide.