A Simple but Comprehensive Guide for Profit Maximization.
Welcome to another Volume of Business/Applied Economics. This time we deal with a concept a little more challenging. So, buckle up!. Most business advice treats pricing like a marketing choice. Applied economics treats it like a measurement problem. Applied Economics is the use of economic theory and data to make real decisions about prices, output, and strategy.
Pricing is often the fastest lever for profit because it changes revenue on every unit you sell, today. A 3 percent price change can move profit more than a 3 percent cost cut, especially when fixed costs are large. Sometimes the best move to increase total revenue is not to increase price, but maybe decrease it (Law of Demand, Scarcity)
This blog specially walks through the core logic firms use, the Demand Curve, marginal revenue and marginal cost, and the rule that profit peaks at MR=MC. You’ll also get a simple tour of the standard diagrams (demand, MR/MC, isoprofit, isocost), one real-world section inspired by current pricing practices, and a short set of Top Tips for Startup owners you can apply this week. (PS: If you are unaware of these topics, please read the previous contents of the volume.)
The science of pricing: How firms analyse data to their advantage
A firm’s pricing problem is simple to state and hard to do well: choose a price and output that raises profit, not just volume. In microeconomics, Profit Maximization means choosing the quantity where the extra benefit of selling one more unit equals the extra cost of producing it.
Here’s the decision rule you can actually use:
Your Demand Curve tells you how many units you can sell at each price.
From that, you can infer marginal revenue (MR), the added revenue from one more unit.
You compare MR to marginal cost (MC), the added cost from one more unit.
You expand output while MR is above MC and stop when MR=MC.
One main thing which connects this to real life applied economics is DATA. A firm must realise that neither this theories, or tools can work without analysing real data. A firm must use statistical investigation, presentation or rely on external agencies and government RTA acts to gather relevant information and analyse the markets. This is where statistics come. A point where statistics and economics are combined.
A short numeric example of the following, is given below:
Assume your a firm. You sell a subscription. At $30, you sell 1,000 units per month, revenue is $30,000. At $28, you sell 1,100 units, revenue is $30,800. Lower price raised revenue by $800. The “extra 100 units” brought in $800, so MR is about $8 per extra unit (in that range).
A model depicting the same
Now look at cost. Suppose your marginal costs are support time, payment fees, and onboarding, totaling $6 per user at this scale. Since MR ($8) exceeds MC ($6), adding customers at that margin adds profit. If a price cut brings in users with MR below $6, it grows sales but shrinks profit. This is why “Increase sales” and “increase profit” are separate goals, even when Management wants both.
Firms apply this logic to several decisions (of course on a much larger macro scale):
Setting price: Use experiments, segmented pricing, or competitor benchmarks to map the demand curve, then choose a point consistent with MR=MC. For a clear refresher on the rule, see The Profit Maximization Rule.
Choosing output: If you can’t change price quickly (contracts, regulations), you still choose output where MR meets MC.
Planning Promotion: A promotion shifts demand (more on that next). But a promotion also raises MC sometimes (returns, churn, overtime). Profit-focused promotion requires measuring both.
Deciding when to stop producing: When MC rises due to overtime or rush shipping, the “last units” may lose money even while average profit looks fine. Hence, the market equiibrium acts like a magnet.
One thing, to be noted is that, in this model we assume firms to play a coordinated game, where both firms chose Nash Equilibria. Uncoordinated games and the concept of Game Theory will be introduced in further volumes
Demand curve basics: what changes price sensitivity and how it affects firms pricing
The demand curve shows a tradeoff: if price rises, quantity demanded tends to fall. What matters for firms pricing is the slope. Here is how the demand curve actually behaves under various tensions:
Demand is flatter (more price-sensitive) when:
There are close substitutes (buyers can switch easily).
The item is a large share of the buyer’s budget.
Switching costs are low (canceling is simple, data is portable).
Demand is steeper (less price-sensitive) when:
Differentiation is strong (brand, unique features).
Switching costs are real (training, integrations, contracts).
Buyers don’t track prices closely.
These concepts also tie to Price Elasticity of Demand (curves are graphical representation of market elasticity)
Understanding the following below can help in impromptu but accurate decisions:
Moving along the curve: you change price, quantity changes.
Shifting the curve: the whole relationship changes because of Promotion, product quality, a new competitor, or seasonality.
For Example: a startup tests $25 vs $35. At $25 it sells 400 units, at $35 it sells 300. Revenue is $10,000 in both cases. If the extra 100 units at $25 have high support costs, profit may be higher at $35 even though sales are lower. That’s the tension between Maximizing Sales and maximizing profit. You can increase sales with a low price, but you might not increase profit. Further ahead, concepts like Isocost curve restraint will help you visualise this better.
MR=MC equilibrias explained simply: where profit peaks, where break-even happens, and what “abnormal profit” means
Marginal revenue (MR) is the extra revenue from selling one more unit. Marginal cost (MC) is the extra cost from producing one more unit.
The rule is operational (maybe situational):
If MR > MC, the next unit adds more revenue than cost, so profit rises.
If MR < MC, the next unit costs more than it earns, so profit falls.
Break-even is a separate idea. The break-even point is where total revenue equals total cost. Any point above it gives positive economic profit, often called abnormal profit in teaching materials (profit above the normal return needed to keep resources in the business). At the break-even point in the MR-MC model, profits earned by proprietor is also considered a cost and considered. Same goes for dividends. Any additional profit is considered “Abnormal.” These abnormal profits are called in much recognizable language, Retained Earnings.
Common mistakes that block profit:
Pricing at average cost only (it ignores demand and MR).
Chasing Maximizing Sales without checking rising MC.
Ignoring capacity limits (MC jumps when you hit overtime, stockouts, or slower delivery).
Refer to CORE Econ’s section on setting price and quantity to maximize profit for additional information
Understanding the language that firms use: isoprofit, isocost, and the tangency point
Photo by Nataliya Vaitkevich
In many Economic Models, the firm faces a constraint and chooses the best point within it. The demand curve is one constraint: you can’t sell 1,000 units at any price you like. Isoprofit and isocost diagrams add another layer: they show how different price, quantity, and input choices map into profit and cost. Think of Isoprofit and Isocost curves as indifference curves but for firms. It shows all the points of profits and combinations of costs, which the firms are indifferent towards. (and the budget line / Demand constraint should aim to achieve the highest Isoprofit curve.)
Steps to Recreate:
Step 1: Put quantity on the horizontal axis and price on the vertical axis.
Step 2: Draw the demand curve sloping down, showing feasible price and quantity pairs.
Step 3: Now draw several Isoprofit Curve lines as downward-sloping curves. Each one shows combinations of price and quantity that yield the same profit.
Step 4: Curves farther up and to the right represent higher profit, because they imply higher revenue net of cost.
Profit maximization becomes a geometry problem: pick the highest isoprofit curve that still touches what’s feasible. The best point is a tangency point where the highest reachable isoprofit curve just kisses the constraint. In the standard single-product model, that tangency logic lines up with MR=MC.
This is a compact way of stating “profit is maximized at the tangibility point of demand and isoprofit.” But, In practice, it means your best price and quantity is where improving one side forces a loss on the other side.
For a more formal explanation of isoprofit slope, please refer to CORE Econ’s page on isoprofit curves and their slopes provides the standard treatment.
Isoprofit curve intuition: what “higher” means and how it connects to the demand curve
Higher isoprofit curves mean higher profit (similar to how a budget line tries to reach the highest indifference curve), but demand decides which ones are reachable. If demand shifts right (more buyers at each price), the firm can reach a higher isoprofit curve without changing cost. If demand becomes more elastic (flatter), the optimal markup tends to shrink because raising price causes a bigger drop in quantity.
Managers aren’t stuck choosing only between “raise price” and “cut cost.” They can manipulate demand:
Product differentation can steepen demand for premium tiers.
Bundling can reduce direct price comparisons.
Targeted Promotion can shift demand right for a segment that values the product more.
These are examples of Applying Economics in Real Life, and how Economics once again proves itself as an Mathematical Discipline.
Isocost lines and the tangency rule: choosing the best mix of inputs and output
An isocost line shows combinations of inputs that cost the same. For example, imagine output depends on labor hours (L) and machine hours (K). If labor costs $20 per hour and machine time costs $40 per hour, then any bundle where 20L + 40K equals your budget lies on one isocost line.
Tangency shows the best tradeoff: the slope of your production choice (how many extra units you get by swapping inputs) matches the slope of the isocost (the market tradeoff between inputs). This mirrors an Indifference Curve story in consumer theory, where the best choice is where an indifference curve is tangent to a budget line. Here, firms use the same geometry with costs and production.
When cost control improves (lower wages, better procurement, automation), the isocost shifts inward. That lets you reach a higher isoprofit. Real constraints still matter: capacity, regulation, and contracts can keep firms away from the textbook optimum. (Note: However, unethical cost cutting and rapid unemployment, may have ethical implications leading to boycutts.)
Applied economics in the real world: How YOU can use these. (by making a profit checklist)
Pricing in 2024-2025 keeps showing the same logic, even when the tools look modern. Dynamic pricing systems, retail scale strategies, and menu engineering all map back to demand shifts, marginal costs, and the search for a point consistent with MR=MC.
Case study: Real Managerial Economics Example:
Hotels often adjust room rates in near real time. When a concert weekend hits, demand shifts right. In diagram terms, the demand curve moves outward, MR rises at each quantity, and the profit-maximizing price increases if capacity is fixed. That’s the demand-shift story many travelers experience.
Walmart’s everyday low prices approach fits a different diagram. Its scale and logistics push costs down, which shifts the cost side in its favor. With a lower MC, Walmart can profit at a lower price while keeping volume high. The key is that low price works because MC is kept low, not because “sales volume” alone pays bills.
Taco Bell’s value pricing and menu changes, often paired with app-based deals, is also a demand management story. Value tiers can pull in price-sensitive customers without forcing the whole menu to compete on the lowest price. In graph terms, segmentation changes the effective demand curve for each group.
CPG brands often use seasonal and event-based pricing. The demand curve rotates and shifts around holidays and sports events. If promotion shifts demand right but also raises costs (rush production, slotting fees), the MR=MC check keeps the plan honest.
Behavioral economics meets pricing: why the best price on paper can fail in practice (and what if a consumer behaves “irrationally”)
Behavioural Economics reminds us that buyers don’t respond to price like calculators. They use reference prices (what they “expect” to pay), they react strongly to losses, and they care about fairness. They may behave irrationally and respond different to different policy changes. One can never know whats going on inside anothers mind!
Surge pricing backlash is a classic case. The firm may be at MR=MC on paper, but perceived unfairness makes the effective demand curve shift left. “Shrinkflation” can trigger the same reaction when customers feel tricked, even if the per-unit cost story is real.
Practical fixes usually involve framing (kind of like a checklist), not only math:
Offer tiers (basic, standard, premium) so the higher price looks earned.
Bundle add-ons to reduce sticker shock. (empirical research has promoted this)
Use promotion designs that protect trust, like clear time limits and transparent reasons for change.
Pro Top Tips for Startup owners (a weekly checklist for profit):
Run two-price tests on a small segment before a full rollout.
Track marginal cost per unit weekly (fees, support time, returns).
Separate goals: Increase sales when retention is strong, prioritize profit when capacity is tight.
Measure promotion lift as incremental profit, not just clicks or units.
Watch capacity thresholds where MC jumps (overtime, shipping, churn).
Re-price when demand shifts (seasonality, competitors, new features).
Document one “MR=MC” decision each month so pricing becomes routine Management practice.
Conclusion
Applied economics turns pricing into a repeatable method. Estimate your demand curve, calculate what the next unit earns (MR) and costs (MC), and stop expanding where MR=MC. The diagrams tell the same story from another angle. The best choice is the highest reachable Isoprofit Curve, found at a tangency point given your demand and cost constraints, and any point above break-even delivers abnormal profit.
Steps, I suggest: measure marginal cost, run small pricing tests, track promotion profit, and revisit price when demand or costs shift. Treat these models as a habit, not a one-time calculation And MOST important. Regularly, collect Data to effectively and accurately use these tools. A firm must graph out all the combinations of profits it can tolerate, demand constraint. An effective manager aims to fill the gap between the Demand constraint and the highest achievable Isoprofit curve! The guide mentioned above is only for educational purposes. Please contact at economicspowered@gmail.com for any additional enquiries.
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