Product Markets and Profit Maximization
We have many firms in the United States, and all of them behave in different ways. Some are extremely competitive,
while others are not so competitive. Some companies sell similar products; others sell very different or original products.
Any generalization is difficult because of the number of companies that exist. Without some means of simplification,
we’d have to consider hundreds of thousands of firms every time we wanted to discuss the supply side of the market.
Economists have devised a classification model based on producing and selling environments. There are four possible
categories or market structures: perfect or pure competition, monopoly, oligopoly, and monopolistic competition. In this
chapter, we review these market structures in detail and examine the behaviors of firms.
Maximizing Profits
Firms use a combination of resources to produce a good or a service to sell on the open market. A firm’s value increases
if its resources are paid for and it has monetary value left over. Adding value is an objective for profit as well as nonprofit
organizations. The purpose of a profit-oriented firm is to maximize profit. The purpose of a nonprofit organization is to
create an output that is more valuable than the cost of inputs. For instance, a temporary aid shelter is a nonprofit organi-
zation. The shelter gives needy families food and monetary assistance. The cost of running the shelter is outweighed by
the added value of the shelter. The shelter’s outputs, or in this case assistance to families, has a higher monetary and non-
monetary value than the costs of its inputs. Adding value is the purpose of business activity. In the long run, organizations
that fail to add value will not survive. Inefficient decisions and allocations will eventually be replaced or overturned by
more efficient ones.
Measuring added value can be difficult for some firms. Nonprofit firms have a more difficult time measuring added
value than do profit-maximizing firms. Added value still remains the goal of both, regardless of the difficulty. Inputs
consist of four general groups: land, labor, capital, and entrepreneurship. The cost of each is:
■ Rent = Landowners
■ Wages and salaries = Workers
■ Interest = Owners of capital
■ Revenue/profit = EntrepreneursWith every factor of production there is a monetary and a nonmonetary cost. The nonmonetary cost comes in the form
of opportunity costs—the amount necessary to keep the resource owners from moving the resources to an alternative
use. If a landowner can rent his land to someone else for a higher price, he will. He has to be paid the opportunity cost
of the land. If Joe can earn more money as a waiter rather than as a host, he will choose to become a waiter unless he is
paid the opportunity cost of staying a host.
The cost of capital is also an opportunity cost. Capital is usually acquired through loans and sale of ownership. The cost
of debt is the interest paid on the debt. Remember that every choice has an opportunity cost and an opportunity benefit.
Businesses are no exception to this rule. Like individuals, businesses have to make decisions based on costs and benefits.
Marginal Revenue and Marginal Cost
When a firm decides to produce and supply a product, it is doing so after it has evaluated its costs and benefits. This evalu-
ation is called a costs and benefits analysis. To analyze the firm’s decisions, we must look at costs and product decisions.
A firm’s downward-sloping demand curve lets the firm know that higher prices will lead to lower quantity demanded.
This essentially tells firms that total revenue first rises and then declines as the price is lowered down along the demand
curve. Maximum revenue is the point at which the price elasticity of demand is 1, but this is not necessarily the profit-
maximizing point. We find the profit-maximizing point by comparing marginal cost and marginal revenue.