11/8/2021

 Total Revenue: total earnings from the sale of

a given quantity of output.
TR  P  Q
 Average Revenue: amount earned per unit of
output sold.
AR  TR P
Q
 Marginal Revenue: the change in TR that
arises from selling an additional unit of
output.
MR  TR
Q

 Marginal Revenue: MR curve will

Average Revenue: if a firm is very small relative
be the same as AR curve, since

to the whole industry it is likely to be a price
taker. selling one more unit at a
D S
P MR/AR
constant price merely adds that
5
P=MR=AR=D
amount to TR.
 Total Revenue: Price is constant
and TR rises at a constant rate
10 bn Q Q as more output is sold.
INDUSTRY FIRM

 Ifprice has to be reduced to sell

 If a firm has a relatively large market
more output, AR will fall as output
share it will face a downward sloping
increases.
demand curve.
 To sell extra output it must lower its
Output P=AR TR MR
0 9 0 8
price. 1
2
8
7
8
14
6
4
3 6 18
 Firm may choose to raise its price 4 5 20
2
0
5 4 20
but it will have to accept a decline in 6 3 18
-2
-4
7 2 14
sales (moving up the demand curve).

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 11/8/2021

 When a firm faces a downsloping demand  If demand is price elastic a

curve, MR will be less than AR.
 Firm sells more by reducing price but the
decrease in price will lead to an
price reduction is not just for the extra increase in TR. MR will thus be
units it wishes to sell; but those it would positive.
have sold had it not lowered the price.
 If demand is inelastic a
 Thus MR is the price at which it sells the
last unit minus the loss in revenue decrease in price will lead to a
incurred by reducing the price of those fall in TR. MR will thus be
units it could otherwise sell at a higher
price. negative.

 Unlike the case of the price-taking

AR/MR
firm TR curve rises at first and then
falls.
 For as long as MR is positive (demand
AR=D is elastic) a rise in output will raise TR.
0  If MR is negative (demand is inelastic)
Q
TR falls when output is increased.
 TR is maximum when MR=0 where
MR PED=1.

PED > 1
P D
(elastic) PED = 1
(unit elastic)

PED < 1
(inelastic)

TR Q
c

TR

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 Π=TC-TR.
 Two ways of maximising
 If TR-TC is positive, firm enjoys
profits.
abnormal or economic profits.
a) Total revenue (TR) and total
 If TR-TC is zero, firm enjoys
cost (TC) curves.
normal or zero economic profit.
b) Marginal/Average revenue  If TR-TC is negative, firm
(MR/AR) and Marginal/Average experiences abnormal or
cost (MC/AC) curves. economic loss.

Q TR TC Profit TC
0 0 6 -6 TR/TC
1 8 10 -2 Profit
2 14 12 2
3 18 14 4
4 20 18 2 TR
5 20 25 -5
6 18 36 -18
7 14 56 -42 0
Q
• π
is maximised when the gap between TR and
TC is greatest, i.e. when 3 units of output are
sold.

 Two stages involved:

Q P=AR TR MR TC AC MC Profit
 Stage One: Find profit
0
1
9
8
0
8
8
6
6
10
-
10
4
2
-6
-2 maximising level of output
2 7 14 12 6 2
3
4
6
5
18
20
4
2
14
18
4
2
3
1
2
4
4
2
using MR and MC curves.
0 4

 Stage Two: Find out how

5 4 20 25 5 2 7 -5
6 3 18 -2 36 6 11 -9
7 2 14 -4 56 8 20 -42
much profit is made using AR
and AC curves.

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 Profitsare maximised when MR=MC. Revenue MC

 If MR>MC, there will be a bigger and Cost
per Unit
addition to revenue (MR) than cost
(MC) thus profits are increased by
increasing output.
 If MR<MC, there will be a bigger
MR
3 Q
addition to cost than revenue thus
profits are increased by decreasing • The marginal curves are used to identify

output. the profit maximising level of output (Q=3)

 Once profit maximising level of

Revenue
output is found, average curves are and Cost
used to determine maximum profit. per Unit
MC
 First, average profit is found by AR=6 AC
Abnormal
subtracting average cost from AC=
Profit

average revenue (AR-AC).

 Average profit is now multiplied by AR=D

profit maximising level of output MR

[(AR-AC)*Q]. 3 Q

 FCs must be paid even if the firm

produces no output.
 For as long as the firm is more than
covering its variable costs, it can go
some way to paying off its FCs.
 The firm should therefore shutdown if
it cannot cover its variable costs.
 Maximum allowable loss is equal to FC.
 Thus shutdown condition is AR=AVC.