Maximising Profit

Maximising Efficiency and Profit

We discussed maximising sales in our previous topic, but improved sales don’t necessarily mean increased profit. Here’s how to calculate costs and revenue to ensure you get the best profit margins possible.

What is Marginal Cost?

Marginal Cost (MC) is an increase of costs due to expanding production or capacity. Initial Marginal Cost is often high, because your basic overhead and labour costs are shared by low quantities of products produced.

As production quantity increases, fixed costs such as overhead and labour are divided by larger quantities of the product created, and your Marginal Cost thus starts to decrease gradually.

However, your production levels will reach a critical point where new investments are required. For example, you might need to hire more people or invest in more equipment or a new kitchen to produce a higher volume. At this point, your Marginal Cost will increase. It is thus important for you to maintain the production level where your revenue is maximised and your Marginal Cost is less than your increase in revenue. At this level, profits are maximised.
 

What is Total Revenue?

Total Revenue (TR) refers to your total sales. This is the amount you collect from selling a certain quantity of dishes.
 

What is Marginal Revenue?

Marginal Revenue (MR) is the revenue obtained from the last unit sold. For example, if you get $500 from selling 100 chicken rice sets and you make $505 from selling 101 chicken rice sets, your Marginal Revenue is $5. This is computed by taking the change in Total Revenue divided by the change in quantity.

MR (Marginal Revenue) = Change in TR (Total Revenue) / Change in Quantity

What is Average Total Cost?

The Average Total Cost or Average Cost, as the name suggests, is how much it costs to produce a unit of product. This is different from Marginal Costs, which refers to the change in production cost per unit, as per the last unit produced.
 

Applying the terms

It is important to know the terms above because they help you understand simple economic concepts that economists use to derive optimal prices for maximising profits. We’ll start with this example

To maximise profits, operators should produce at quantities where:

Marginal Cost = Marginal Revenue (MC = MR)

When MC > MR, the cost to produce an additional unit is more than the extra revenue generated. For example:

If the restaurant sells a quantity of 105 chicken rice sets, his MC ($1.39) is much smaller than his MR ($5). At this production level, his TR is $525 while his TC is $450. This means his profit is $75.

However, if he produces a quantity of 282 chicken rice sets, his MC ($4.88) is almost on par with his MR ($5). At this production level, his TR is $1,410, his TC is $1,100 and his profits are $310.