Final answer:
Activity-based costing improves planning and product costing in firms by allocating costs based on activities. It helps in understanding the effects of production changes on marginal revenue and cost. A combination of cost metrics with sales and market analysis aids in profit maximization.
Step-by-step explanation:
Firms can improve planning, product costing and control by using activity-based costing to develop a detailed description of the specific actions performed in the firm's operations. This method allows firms to more accurately allocate costs to products and services by identifying the activities that consume resources and assigning costs to those activities based on their use of those resources. By doing so, firms gain a better understanding of where their money is going and can make more informed decisions regarding production levels and pricing strategies.
While companies may struggle with predicting total costs at different production levels due to a lack of past data, they can experiment by adjusting production slightly and observing the effects on profits. This practical approach to profit maximization relies on understanding how changes in production influence marginal revenue and marginal cost.
From a long-run perspective, firms benefit from dividing total costs into fixed and variable costs. This division is the basis for deriving important cost metrics such as average total cost, average variable cost, and marginal cost. Combining these metrics with a thorough analysis of sales and revenue, and considering the market structure the firm operates within, forms a comprehensive approach to determining the profit-maximizing quantity of production and optimal pricing.