Imran, Muhammad.

Student ID No: 1120136004, Nankai University Tianjin China

Profit maximization:

Economic profit is defined to be the difference between the revenue a firm receives
and the costs that it incurs. It is important to understand that all costs must be
included in the calculation of profit. A basic assumption of most economic analysis
of firm behavior is that a firm acts so as to maximize its profits; that is, a firm
chooses actions(a
l
,... ,a
n
) so as to maximize R(a
l
,... ,a
n
) - C(a
l
,... ,a
n
).
Lets consider the problem of a firm that takes prices as given in both its output
and its factor markets. Let p be a vector of prices for inputs and outputs of the firm.
The profit maximization problem of the firm can be stated as
(p) = Max py.
Since outputs are measured as positive numbers and inputs are measured as
negative numbers, the objective function for this problem is profits: revenues
minus costs. The function (p), which gives us the maximum profits as a function
of the prices, is called the profit function of the firm. In general we will take prices
to be row vectors and quantities to be column vectors.
Now lets consider the problem of profit maximization in the perfectly competitive
market, where
Max [py wx]
Where p, y, w and x are the price of the produce, output level, wages and inputs
respectively.
s.t y f(x) x 0
because firms will produce on the production frontier to get the maximum amounts
so this condition can be substituted as y = f(x)
Than maximizing the profits
Max [ p.f(x) wx]
Imran, Muhammad. Student ID No: 1120136004, Nankai University Tianjin China
p .

- w = 0



Py - wx =
0

y =

x +

taking the first order derivative of y ..

= f ' (x*) = MP, and for convexity its second order

derivative must be less than or equal to zero...
f '' (x*) 0

In case of two inputs to produce single output y = f (x
1
,x
2
). Lets (x*
1
,x*
2
),
production function y= f(x*
1
,x*
2
) and cost function is C*= w
1
x*
1
+ w
2
x*
2
,
combining these equations in figure

Imran, Muhammad. Student ID No: 1120136004, Nankai University Tianjin China

by maximizing the left side equals to TRS

ij

Q(y*) : y* = f(x
1
,x
2
)
C* = w
1
x
1
+ w
2
x
2


The point where y* and C* lines intersect make equilibrium amount of x
1
and x
2
inputs while producing the optimum amount of output y (i-e y*). The two
important points in this figure are the intersection point should be convex in
isoquant, and second, no double intersection points for isoquant if there are then it
means there are two isocost lines but for this industry costs are given C* which
mean slopes of two curves are equal at the point of intersection

Corner Solution for Profit maximization:
If the situation is not for two inputs means single input then profits can be
maximized through the special technique of Kuhn-tucker theory.
Imran, Muhammad. Student ID No: 1120136004, Nankai University Tianjin China
L = p.f(x) wx +

= p.

- wi + = 0 0
If x*>0 then *= 0, solving the

we get
If x*>0, then p.f(x*) - w
i
=0
x*= 0, then p.f(x*) - w
i
0

Its well reflected from the diagram that there is only one input used to produce y*.
i-e (x
1
,0) and