Profit Maximization Graph
The profit maximization graph is a visual representation of the relationship between output levels and profits for a given business. A profit maximization graph helps to determine the level of output at which the profit is maximum.
Component of Graph:
1. Marginal Revenue (MR) Curve: Marginal Revenue curve represents the additional revenue earned from the sale of one additional unit of the product.
2. Marginal Cost (MC) Curve: Marginal Cost Curve represents the additional cost incurred by a firm to produce one more unit of a good or service.
3. Break-Even Point: The break-even point occurs where the MC and MR curves intersect, indicating the level of output at which revenue earned is equal to the cost incurred. At this point, the firm is covering all its costs but is not yet making a profit. It is a situation of ‘no loss – no profit.’
4. Profit (π) Curve: The profit curve is derived by subtracting cost from revenue at each output level. The point where the profit curve is at its peak indicates the level of output at which profit is maximized.
5. Profit-Maximizing Output: The profit-maximizing output level is found where Marginal Revenue (MR) equals Marginal Cost (MC).
6. Optimal Production Level: The profit maximization point represents the optimal production level for the firm; i.e., the intersection point of the Marginal Cost (MC) curve and the Marginal Revenue (MR) curve. Producing more or fewer units would result in lower profits due to diminishing returns or underutilization of resources.
Explanation:
In the above graph, the X-axis represents the output, and the Y-axis represents the cost and price. A Marginal Revenue Curve is a horizontal line parallel to the X-axis, and a Marginal Cost Curve is U-shaped. Point R and K are two points of intersection where MC equals MR. Since after point R marginal cost remains lower than marginal revenue, the firm will continue to increase its output to earn more. So, point R despite being the point of intersection cannot be considered a Profit Maximization Point. Hence. in the above graph point K is a point of profit maximization because:
1. At point K, Marginal Revenue (MR) = Marginal Cost (MC).
2. Beyond this point marginal cost becomes more than marginal revenue.
So, the firm earns a maximum profit at this level of output, i.e., at OQ1 ( Profit-Maximizing Output).