Profit Maximization Report, Research Paper Example

This paper looks at the cost structure of Chevron Inc which is an energy firm that specializes in oil production. The cost structure of the firm comprises of the various cost elements that account for the activities and operations of the firm. Chevron relies on the cost structure that entails the following cost elements; fixed costs which arise due to the virtue of the business being in operation such include rental bills for offices, variable cost that change according to the level of output such entail direct labor cost of producing oil, oil exploration costs, power costs used in production and other overhead variable costs. The marginal costs are expenses that can be attributed to the production of total output. Marginal cost structure of the energy company comprises all the cost incurred in selling the products, all the costs incurred during the production process and all administration expenses (Richard, 2010).

The element of profit maximization for the firm relies on how well the company is in control of the marginal production cost and the marginal revenue. In purely competitive market where market conditions are determined by the forces of demand and supply against the price quoted by the various players in the market, the energy firm stands the chance to achieve profit maximization if its marginal revenue exceeds the marginal cost of production. Profit maximization based on the Break Even Analysis(BEP) can be attained by the firm when the additional sales of its inputs surpasses the point where total revenue equals to total cost and therefore an extension beyond this point results to profit maximization. The total output at the expected selling price in the market should generate total sale revenue to a point where there is a margin of safety between the total marginal cost and total marginal revenue. Profit maximization in purely competitive market can be achieved by the energy firm if it operates under economies of scale whereby each extra unit of output causes a less than proportionate increase in cost of production. Under economies of scale, the firm produces more units at a lower cost due to decline in marginal variable cost of production. To achieve a reduction in the variable cost of production, the company should invest in technology to reduce the cost of production. The company should automate its production operations to reduce the marginal cost of labor and ensure increased investment in Research and Design to develop the most efficient methods of operations. The advantage of economies of scale also spreads to the other cost elements that are associated with marketing and promotion of products, for instance more units will be advertised at low cost (Richard, 2010).

Economies of scale enable the firm to enjoy an increase in marginal profits that come with increase in the production units. The competitive market such as the energy industry price is determined by the supply of the firms in the industry. An increase in supply leads to a decline in demand and thus low prices for the products, however at such cases firms operating under economies of scale still enjoy profits due to more units which sold at the market price. The energy therefore enjoys profit maximization where the marginal costs incurred in the production and sales of the products are equal to the marginal revenue. Proper cost allocation of the cost in the cost structure enables the firm to experience on changes in the fixed costs due to profit maximization. Increase or decrease in the fixed costs elements are not felt by the energy firm due the fact that they are treated as part of absorbed costs in the operations of the firm. Profit maximization of a firm can be achieved by attaining the desired level of outputs at manageable price levels in the market. The energy firm can realize profit maximization by properly managing the marginal costs and hence increase the margin between marginal revenue and the total cost incurred in production (Richard, 2010).

Differences in cost of production among the energy firms can be attributed to the issue of economies of scale. From the above observation economies of scale lowers the cost production and increases profitability. Price changes in the market leads to low profitability to the firms that do not apply the element of economies of scale. Firms in the energy make losses when prices are highly fluctuating due to regulations by the government in the sector. Such regulations affect the prices of the commodities and thus leading to losses, however in such cases the firms continue to remain in operation despite the losses they believe that regulations calls for adaption (Richard, 2010).

Applying the incremental cost and contribution analysis, it is therefore deemed important that the firm manages variable cost by adopting cost efficient methods of production such as applying technological advancements to reduce the cost of production. Marginal costs are important for decision making since they can be used to determine the relationship between the variable costs, sales revenue and profitability of the firm. Marginal cost entails all the important cost elements that are employed in the process and the daily operations of the firm, such cost entail the direct labor cost, direct material cost of raw materials, direct expenses important for the operations of the firm and all the variable overheads. Marginal costing method enables the management of the energy firms to allocate these costs according to the extent of their significance and thus ignore those costs which are not significant for the success of the firm.

Conclusions

Chevron being a profitable energy firm and therefore deserves to remain in the business should determine a proper management method of the various cost elements that underlie its operations in the industry. To remain profitable and sustain its operations in the energy industry, Chevron has to ensure that it can easily adapt to changes in prices of the commodities in the market. A decline in prices may affect its profitability however, if the firm operates under economies of scale, it can stand the chance to avoid such situations. The firm should ensure that it can effectively manage its marginal costs to ensure that can realize more profits. This therefore implies that the firm’s management has to design proper cost management strategies.

References

Richard, G. (2010). An introduction to positive economics, 4^th Ed. Weidenfeld and Nicolson. pp. 214–7. ISBN 0-297-76899-9.