Revenues and Profits

Total Revenue- is defined as the total money collected from the sale of goods and services.
It is derived by multiplying the price of the goods and quantity of goods sold.
Formula:
TR= P x Q
Total sales = Price x Quantity

If a firm sells 20 unit of good for 25$ each

TR/Total Sales = P X Q
=$25x20
= $500

Average Revenue
Is average revenue per unit. It can be found by dividing the total revenue of the firm by the
number of units sold.
AR= TR/Q
AR= Total revenue/ quantity

NB. average revenue is basically price.

Marginal Revenue
This is the change in total revenue from selling one more unit of output.
Formula: MR = Change in Total Revenue / Change in Quantity
MR = Δ TR/ Δ Q
Revenue Curves
Total Revenue Curve

The total revenue curve shows as we increase the output(quality sold)Q or if we

increase the price, sales or total revenue increases(ceteris paribus)
Average Revenue and Marginal Revenue

Both Average and Marginal Revenue are downward sloping because of the law of
diminishing return.
Profit

This is the amount that is remaining for the entrepreneur after he has deducted the cost of
production from his total revenue /sales.
Profit/ π = TR - TC

Types of Profit(Economic Profit)-

Proft can either be:

-Subnormal Profits
-Normal Profits
-Abnormal/Supernormal Profits

Recall that; Profits serve as the motivation for firms to produce goods and
services.

1. Normal Profits
Is the minimum number of profits that is necessary to encourage a firm to
continue production. Usually, this may be determined by the amount an
entrepreneur could receive in his next best venture/job (opportunity cost)

E.g. An engineer who earns $100,000 per month by working in a construction job
decides to start his own business. The level of normal profits that he will be willing to
accept is $100,000 per month.

This means that if the business owner(engineer) makes a profit which is below 100,000
a month he will close down and take back his job in construction (his next best
alternative).
Normal profits are added to the wages, rent and interest to make up the cost of
production.

NB. When the total revenue is equal to the total cost, normal profit is earned. Therefore
average revenue is also equal to average cost.
TR= TC and AR= AC
Supernormal Profits

Abnormal/supernormal profits is any excess over normal profits. For these reasons, it is
also known as surplus profits.
Abnormal Profits occur when total revenue is higher than the total cost .
TR>TC
This implies also AR>AC (Average revenue > average cost)
Using the engineer’s example from above if he is making 200,000$ in his business this
is considered supernormal profits as it exceeds the normal level he expected.

Subnormal Profit
Any profit less than normal profit (normal profit is the necessary profit needed to
encourage a firm to continue production).
Eg. Referencing the same engineer if he made 80,000$ in profit this would be
subnormal because it is below the minimum expected profit of 100,000$

Exercise

Q Price TR=(P x Q) AR(TR/Q) MR-Change in

TR

1 300 300 300 -

2 280 560 280 260

3 260 780 260 220

4 240 960 240 180

5 220 1100 220 140

6 200 1200 200 100

Hw. 1.Find out the main objective of producers
2. What is the profit maximizing condition and what is profit maximizing

Profit Maximization

The objective of a producer is to maximize profit. This means that the firm will
take advantage of every opportunity to earn additional profit.

eg. Assuming that uncle Ben owns a taxi car, everyday a minimum of $8000 in fuel and
repairs must be made ,in addition the taxi driver must make at least $12000 for himself.
Uncle Ben is offered $25000 to transport Sallie around GT per day . He would take the
job . This is because the marginal revenue covers the marginal cost of providing the
service. Therefore, the taxi driver makes a normal profit of $12000 as well as an
abnormal profit of $5000.In this scenario (MR>MC)

On the other hand, if uncle ben was offered $20000 to do a job with Edward, he would
take the job as well. This is because the marginal revenue is equal to the marginal cost
and will receive a normal profit of $12000.In this scenario (MR=MC)
However if Uncle Ben was offered 17,000$, he would not take the job , because the
marginal revenue is less than the marginal cost and hence subnormal profit is earned.
In this scenario (MR<MC)
What can be observed from these three scenarios;
When marginal revenue is more than MC , he will take the job. He will still take the job
when MR=MC as he is making normal profit. It must be noted that MR+MC is the profit
maximizing position. Any profit maximizing firm will produce until they are at this
position as they are still able to make the maximum profit they are looking for. Any
situation where MR<MC the firm will not operate.

Q Total Margi Total Marginal Total Marginal

Reven nal Cost Cost Profit Profit
ue Reven (TR-
ue TC)

0 $0 - $20 - $-20 -

1 $60 $60 $70 $50 -$10 -10

2 $120 $60 $100 $30 $20 30

3 $180 $60 $140 $40 $40 20

4 $240 $60 $200 $60 $40 0

5 $300 $60 $280 $80 $20 -20

N.B
The total cost is still $20 when the firm produces zero output because these costs
are fixed.
When the firm sells the fourth pair, MR=MC. The fifth pair of output would cost the firm
$80 to produce and $60 revenue and when sold generates a loss of $20. Therefore the
firm would not produce the fifth pair as they are making a loss and profit is maximized at
the fourth pair.

Revenue /Cost Firms Output

When
MR> MC The firm should sell more output

MC>MR The firm should decrease output

MR=MC Profit maximization is achieved, and

the firm should not produce more

Other objectives of the firm

-In reality most firms aim for maximum profit in the long run, however, they may adopt
other objectives along the way:

1. Sales maximization /growth in market share

Some firms may cut their price to encourage more customers to buy their
product. As the firm gets more customers, its market share increases, but the
lower price may result in lower profits.

2. Survival (Profit Satisficing) - A firm may set prices low to keep customers from
switching to other products. This will enable the firm to stay in business, but profit
remains low.
3. Predatory Pricing /Behavior- This is where an established firm in most cases a
monopoly/oligopoly sells at lower prices to force competition out of the market.