"To maximize profit, you need to sell your output at the highest price."  With regard to different costing systems and pricing of products, analyze the validity of this statement. How should...

"To maximize profit, you need to sell your output at the highest price."  With regard to different costing systems and pricing of products, analyze the validity of this statement. How should marginal costs be considered when determining prices?

Asked on by sukhnjot

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pohnpei397 | College Teacher | (Level 3) Distinguished Educator

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This statement is not valid.  On its face, it is impossible.  How does one set “the highest price?”  The range of possible prices for a good is essentially infinite.  Clearly, it makes no sense to set your prices to the highest level that you can imagine.  Even when we read this statement more reasonably, it is still invalid.  Firms do not simply raise their prices to maximize profits.

One way to think about this is to think about price elasticity of demand.  When a firm raises the price of its products, consumers might reduce their purchases.  We saw, for example, that people consumed less gasoline when the cost of gas was up around $4 per gallon in the United States.  The more elastic the demand for your good, the more profit you lose when you raise prices past a certain point.  Therefore, you cannot simply raise prices in order to increase your profits.

When setting prices, firms are supposed to consider their marginal costs.  The profit maximizing point for any firm is the point where its marginal revenue from selling the next unit of product is equal to the marginal cost of producing that unit.   The firm has to determine what its demand curve looks like so it can see what price it can charge at any given level of output.  It then has to set its output at the level where the price it charges brings it a marginal revenue that is equal to its marginal costs.

The statement in your question is not valid.  Firms maximize profits by getting their marginal revenues to equal their marginal costs, not by blindly increasing prices.  

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