This slide share contains the meaning of profits and the first order and second order conditions for profit maximization with numerical examples.Theories of profits are also discussed in brief.

1. PROFIT ANALYSIS
BY
Dr.S.SubbaLakshmi,MA,MPhil,PhD
Chair, Business & Economics
FBS Business School
Vijayawada & Bangalore

2. Profit Analysis
• What is profit ? Generally profit is the
remuneration awarded to the entrepreneur or
organizer or equity share holders for participating
in the production process.
• Why profit occurs to them ? Because they are
the ones who can predict changes in a dynamic
economy, who faces risk and uncertainty, and
initiates the production process , introduces
innovations in various areas of production.

3. Accounting Profit vs. Economic Profit
• Accounting Profit = Total Revenue –
accounting cost (Explicit costs ).
• Accounting costs = only those costs paid in
the form of money. They do not include
implicit costs and opportunity costs.
• Economic Profit = Total Revenue – Total costs.
• Total costs =Accounting costs or Explicit costs
+ opportunity costs +implicit costs.
• Economic profits are known as Pure Profits
also.;

4. Profit Maximization as Business
Objective
• Profit maximization in the conventional theory
is the most productive objective though the
firms have other objectives like sales
maximization.
• Profit =TR-TC, TR is total revenue and TC is
total cost.
• Profit maximization also means cost
minimization.

5. Continued….
• Profit maximization is established with the
following conditions.
• The necessary condition =MR=MC
• dTR/ dQ – dTC/dQ =0
• MR = MC
• This is also known as 1st order condition
• The satisfactory condition =MC should cut the MR
curve from below. That is the slope of MR should
be lesser than slope of MC

6. Profit Maximization
Q Q2
MR
o
P
R
I
C
E
OUTPUT
P1
P2

7. Numerical example
• Demand function for a good is given as
Q = 50-0.5p Given the DD function, price can be
derived as = 100-2Q
• TR=( P multiplied by Q)= (100-2Q)Q
=100Q-2Q2
• Total cost Function = 10+0.5Q²
• Given TR & TC functions the first order condition
for profit Maximization =MR =MC or dTR/ dQ = dTC/dQ

8. continued
• MR = dTR/ dQ = 100- 4Q
• MC = dTC/ dQ = Q. Thus profit maximization=
MR=MC or 100-4Q =Q
5Q =100
Q = 20
• Output 20 satisfies the second order condition
also. That is as follows.

9. continuation
• d2TR/dQ2_d2TC/dQ2 < 0 .In other
words the second order condition
requires
• dMR/ dQ - dMC/ d Q < 0 or
• d( 100-4Q)/ dQ - d (Q)/ dQ < 0
• - 4 -1 < 0
• Thus the second order condition is
also satisfied at output 20 units.•
•

10. Profit policies
1. Maintaining business goodwill.
2. Wage consideration.
3. Avoiding high taxation , and government’s
intervention.
4. Avoiding risk.
5. Goal of domination and leadership in the
market.
6. Enlightened Self-interest of survival.
7. Obstructing potential competition

11. Profit Budget
• It is a planned financial forecast for the net
income of a firm.
• It is a projection of future financial
performance of the company.
• It is a reasonable estimate of projected net
revenue.
• Thus provides information to the shareholders
• about attainability of profitability goals.

12. Theories of Profits
• Innovation theory of profits – Joseph
Schumpeter---
• The main function of an entrepreneurs is to
introduce innovations in the economy . Profits
are the reward for making innovations.
• What is an Innovation ? Two Types
• 1) TO reduce the cost of production. Ex –
introduction of a new machinery, cheaper
technique of production, exploitation of new raw
material etc

13. Continuation
• Second Type of innovation – Increasing the
demand for the product. Ex-Introduction of
a new design to the product, new method of
advertisement, discovery of new markets,
superior method of advertisement.
• Thus profits emerge and are retained by the
entrepreneur if he can get a patent with out
others imitating him . Ex- Bill Gates making
huge profits( windows operating system)

14. Uncertainty bearing theory of Profit:
• It is propounded by American Economist Prof
Knight : Profit is regarded not for risk taking,
but for uncertainty bearing
• Risk is of two kinds . 1)Foreseen risk,
2) unforeseen risk ,which can not be foreseen
by the entrepreneur.
• Unforeseeable risk is uncertainty according to
Prof Knight ,and profit is reward for it and
profits and uncertainty are directly related.

15. continuation
• What are uncertainties ? They are non insurable
risks such as
1. Competitive risk with the entry of new firms,
2. Technical risk , adoption of new technique by
competitors ,
3. Risk of Government intervention such as
administered prices, tax policy , import and
export restrictions.
4. Business cycle risk – the demand for the product
may fall due to business recession and
depression

16. Wage theory of Profit
 Propounded by Prof Taussig and Devenport
 Profits are a form of wages.
 Profits accrue to the entrepreneur on account of his
special ability.
 As laborers receive wages for their service,
entrepreneur receives profits for his service.
 Entrepreneur is as good as any other workers like
doctors, teachers who render intellectual labor , but
they get wages which are part of cost of production.
 Entrepreneur gets profits for his special mental ability
which is the surplus after meeting all the expenses of
production ,that is over and above cost of production.

17. Dynamic theory of profits
1) J.B Clark propounded the dynamic theory of
profits.
2) Profits arise due to continuous generic changes
that happen in the dynamic economy.
3) Increase in population, increase in capital,
improvement in production techniques ,
changes in the forms of business organization,
increase and multiplication of consumer wants
give rise to pure profits

18. Continuation
4 )Pure profit is over and above normal profit.
These are only short term in nature due to
competitive firms imitating the leaders
5) The result is disappearance of pure of pure
profits in the long run.
6) After emergence , disappearance, re-
emergence will take place if managers are
dynamic enough to take the advantage of the
continuously changing generic changes.

19. THANK YOU