Final answer:
Target costing aims to define a product's desired cost to achieve a targeted ROI by setting the selling price equal to the cost of production plus desired profit. In perfect competition, a firm's capacity to gain profit is the difference between total revenue and total cost.
Step-by-step explanation:
Target costing is a technique used in management accounting, where the desired cost for a product is determined based on a given competitive price. This method allows organizations to manage costs with the objective of earning a desired Return on Investment (ROI). Essentially, the goal is for the sales price to cover the cost of production and also include a predetermined profit margin. Figure 3.12 illustrated that the cost of production and the desired profit together will be equal to the price at which a firm will set for a product. In the realm of perfectly competitive markets, profit maximization is achieved by comparing total revenue to total cost. A perfectly competitive firm can sell any quantity at the market price and its profit is determined by the difference between total revenue and total cost. Profit can be expressed as the formula: Total Revenue = (Price)(Quantity produced) - (Average cost)(Quantity produced). The firm's average cost provides insight into whether it can earn profits at the current market price and thus determines the firm's profit margin.