The UK’s European university

Economics for Accounting

ECON3007
Autumn Term
8. Theory of the firm: Production and Costs II
 Aims and reading

• Aims
• What is revenue?
• What is the profit maximization?
• Comparing accounting profit against economics’ profit

• Reading
• Gillespie, Chapters 10 and 11

Page 2
 What is revenue?

What is profit maximization?

Comparing accounting profit against

economics’ profit

Page 3
 Revenue

• Total revenue (TR): a firm measures the value of its

sales
TR = P * Q

Page 4
 Revenue

• Marginal revenue (MR) is the difference in the total

revenue when an additional unit is sold

MR =

Page 5
 Revenue

• Relationship between MR and TR

Page 6
 Revenue

• Marginal revenue and total revenue

Page 7
 Revenue
• Marginal revenue and total revenue

Page 8
 Revenue

• Average revenue (AR) is measured by total revenue

divided by output

AR =

Page 9
 What is revenue?

What is profit maximization?

Comparing accounting profit against

economics’ profit

Page 10
 Profit maximization

• The profit of a firm measures the difference between

the value of what has been sold and the value of what
has been used up to provide these goods

Profit = Total revenue – Total costs

If total costs > total revenue LOSS

Page 11
 Profit maximization

• Normal profit occurs when total revenue equals total

costs

• Abnormal profit (or supernormal profit) occurs when

the total revenue is grater than total costs

• Profit maximization occurs when marginal revenue

equals marginal cost (marginal condition)

Marginal revenue (MR) = Marginal cost (MC)

Page 12
 Profit maximization

Page 13
 What is revenue?

What is profit maximization?

Comparing accounting profit against

economics’ profit

Page 14
 Accounting profit vs economists’ profit

• Accounting costs measures the costs of items used

up to produce and sell the products: labour, materials,
land and equipment (explicit costs)

• Economists’ costs add opportunity costs (implicit

costs)

• If the revenue does not cover economists’ costs then

resources should be moved out of this sector and into a
more profitable one

• In accounting terms, the firm could still be declaring a

profit
Page 15
 Accounting profit vs economists’ profit

• Accounting profit = Total revenue – Accounting Costs

• Economic profit = Total revenue – Economic Costs

Page 16
 The decision of whether to produce or not

• Shutdown point occurs when the price equals the

average variable costs; i.e. TR = TVC
• Short run
• A firm should produce if the price is greater than or equal to the
average variable costs
• A firm should not produce if the price is less than the average
variable costs

• Long run a firm will not continue producing if it is

making a loss

Page 17
 What have we learnt?

• Meaning of revenue
• Profit is the difference between TR and TC
• Profit is maximized at an output for which the MR = MC
• Normal profit occurs when the TR = TC
• Abnormal profit occurs when the TR > TC
• A loss occurs if TR < TC
• There is a difference between an economist’s view of profit and an
accountant’s view of profit
• In the short run, a firm will produce only if the price is equal to, or
greater than, the average variable cost
• In the long run, a firm will produce only if the price is equal to, or
greater than, the average cost

Page 18