The economist hears someone say:
Business firms are all about maximizing revenue. If a firm is currently earning \($10\) million in total revenue, and it can sell 10 more units of whatever it is that it sells—thus raising the total revenue to \($10\) million and \($100—then\) it should do that: The more revenue, the better.
Hear what and how the economist thinks:
The person who thinks that firms want to maximize total revenue would be easily dissuaded of this once costs are brought into the picture.
Suppose a firm could sell one more unit of what it produces for \($400.\) Should it do this? The person would likely say yes. Then we could ask this person if the firm should do this if it cost the firm an additional \($500\) to produce the unit it sells for \($400.\) Now the person would probably say no. It would be taking a loss of \($100\) on that item, and that is not advisable.
In short, it is not total revenue that the firm wants to maximize;
instead, it is the difference between total revenue and total cost, or profit.
The economist says that when it comes to activities, there are usually benefits and costs, not just one or the other. When it comes to producing and selling goods and services, there are benefits to be derived, these are the revenues gained from producing and selling the goods, but there are costs too. To produce and sell a good is to derive a benefit, but it is to incur a cost too. If we focus only on the benefits or only on the costs, we only see part of the whole picture.
Think of a similar example that would likely generate different responses from an individual depending on the variables considered.
Suppose we were to ask someone if firms always hire the cheapest labor. We say to that person: The firm can hire labor in country X and pay \($40\) an hour for labor, or it can hire labor in country Y and pay \($15\) an hour for labor. In which country will the firm hire labor?
My guess is that most people will say in country Y, where labor is \($15\) an hour. But there is something else to consider besides the wages paid to labor, and that is the productivity of labor. Suppose that in country Y a person receiving \($15\) an hour can produce 2 units of A an hour, but in country X a person receiving \($40\) an hour can produce 10 units of A an hour. Is it still in the firm’s best interest to hire the \($15-an-hour\) worker instead of the \($40-an-hour\) labor?
The \($15-an-hour\) worker produces 2 units of A at a per-unit cost of \($7.50,\) while the \($40-an-hour\) worker produces 10 units of A at a perunit cost of \($4.\) Taking into account the productivity of the workers in the different countries, it now appears that the more expensive wage-earner in country X is really the cheaper worker to hire. We would have never come to this conclusion if we had focused on only one variable—the wage cost of workers. It was considering two variables at a time—the wage cost and the productivity of the workers—that led us to seeing the whole and true picture of what matters.
Questions:
1. A person tells us that it is important to get as much exercise as possible. Exercise comes with lots of benefits, she says. Would you agree that it is important to get as much exercise as possible? Explain your answer.
2. Can you identify the condition under which maximizing total revenue would be the same thing as maximizing profit?