A company's profits will vary based on how many products they produce and the price point of the products. Because customers tend to buy more products when they cost less, but the individual profit of an item increases when the product costs more, a business needs to figure out the ideal price point and production level to maximize total business profits.
The easiest way to find maximum profit is by running different scenarios of price, quantity, costs and profit at different price levels, and choosing the ideal price point that will deliver the greatest profit.
Maximum Profit Components
To find the maximum profit for a business, you must know or estimate the number of product sales, business revenue, expenses and profit at different price levels. Profits equal total revenue subtract total expenses. For example, say that at a price of $10, you think you can sell 200 products and incur fixed expenses of $1,000 and variable expenses of $800. The total revenue at this price level is 200 multiplied by $10, or $2,000. Since the total expenses are $1,800, the profit is $200.
Estimating Demand at Different Price Levels
Continue estimating quantity at different price levels. The rule of economics is that the quantity that consumers demand will decrease as the price goes up. However, the amount of scarcity and product competition also affect demand. For example, say that you are also considering selling your product for $15. If you don't have significant competition in the area and there are not alternative consumer products available, your demand may only dip slightly. If there are a wide variety of competitors that sell the same product for less than $15, your demand may decrease dramatically.
Setting up the Data
Create a table and make columns for price, quantity, total revenue, marginal revenue, total costs, marginal cost and profit at different price levels. Marginal revenue is the increase in revenue you receive from selling more of the product. For example, if you earn $2,000 when you sell 200 products at $10 and $2,625 when you sell 175 products at $15, the marginal revenue between the two price levels is $625. Likewise, you can calculate marginal cost by subtracting the total costs at the previous price level from the total costs at the current price level.
Finding Maximum Profit
To find maximum profit, compare the profit level at each price level. The highest level of profit is the maximum profit and the associated product price is the profit-maximizing price. To double-check your calculations, examine the marginal cost at the profit-maximizing level. If you've calculated maximum profit correctly, marginal costs should increase faster than marginal revenue after the the profit-maximizing cost level.