Revenue Maximization Problems in Economics

In a capitalistic business model, business managers are interested in maximizing the total revenues they get in their business operations from the sales of their products. From this revenue, after deducting various costs, the firm earns a profit. Revenue-maximization problems in economics study how to arrive at this revenue-maximization point.

A firm that can sell its goods in the market earns revenue based on the number of units it sells multiplied by each unit's selling price. Revenue maximization for the firm occurs at the point where the firm gets the maximum total revenue it can for its output; this is the point where the firm cannot add to its total revenue by selling more units.

Each unit of output that the firm sells adds to its revenue -- up to a point. Beyond a certain point, the firm will not be able to sell additional units except by accepting a lower price, and these additional units sold will reduce its total revenue. To get the maximum revenue, the firm will focus on selling additional units up to the point where the last unit it sells adds zero additional revenue. At this point, the total revenue the firm gets will be maximized.

Revenue maximization is not the same as profit maximization. A firm may be able to maximize its revenue in a way that does not make for profit maximization. For instance, managers could step up their advertising efforts. While this might hike up sales and lead to additional revenue, the deduction of advertising costs from the revenues means that profits will be reduced. Some firms might adopt a short-term revenue-maximization approach with an eye to long-term profit maximization. For instance, an effective advertising strategy could lead to a competitive advantage for a firm, such as increased consumer awareness, and add to its profits in the long term.

The economist William Baumol came up with the theory that -- thanks to the separation of ownership and management in large corporations -- business managers are more focused on revenue maximization than on profit maximization. This is because incentives given to managers are allied to sales revenue, rather than profits. However, managers must earn a certain minimum level of profit for the company's owners. This poses a constraint on their revenue-maximization approach.