Revenue, costs and profits

 Outline
 1. Measuring revenue
 alternate demand curves

revenue & elasticity
 2. Costs & revenue
 profit maximisation
• output & price

shut-down point
 1. Measuring revenue

 Revenue = P x Q (sales per period)

 total revenue (TR) e.g. £2 x 100 = £200
 average revenue (AR)
• AR
AR =
= TR
TR // Q
Q i.e.
i.e. revenue
revenue per
per unit
unit sold
sold
• £200
£200 // 100
100 =
=22 i.e.
i.e. AR
AR =
= PP
 marginal revenue (MR)
• ‘the
the extra
extra revenue
revenue gained
gained byby selling
selling one
one more
more unit
unit
of
of output
output per
per time
time period.’
period.’
• MR = ∆
MR = TR // ∆
∆ TR ∆QQ
 1a. How does revenue vary with
output?
 Answer: determined by market conditions

 A) When firms are price takers

 i.e. price determined by demand & supply
 Firm output has no effect on market price -
horizontal demand curve
 constant AR, MR at market price
 Deriving a firm’s AR and MR: price-taking
firm
Price (£)

AR, MR (£)
S

D = AR
Pe
= MR

D
O O
Q (millions) Q (hundreds)

(a) The market (b) The firm

 Total revenue for a price-taking firm
TR
6000

5000

4000
TR (£)

3000

2000

1000

0
0 200 400 600 800 1000 1200
Quantity
 1a How does revenue vary with output?
 B) When price varies with output
 firms have control over price -
downward-sloping demand curve
 AR = P. If P↓ to Q↑ then AR↓
Revenues for a firm facing a downward sloping
demand curve
 B) Price varies with output
 MR < AR
• if demand is elastic, a P↓ leads to a
proportionately larger Q↑ (and therefore
revenue)
• MR is positive
• If demand is inelastic, MR is negative
 TR rises (MR+), then falls (MR-)
 AR and MR curves for a firm facing a downward-sloping
8 D curve
Q P TR MR
(units) =AR (£) (£)
1 (£)
8 8
6 6
2 7 14
4
3 6 18
2
4 5 20
4 0
5 4 20
-2
AR, MR (£)

6 3 18
-4
7 2 14
2
AR

0
1 2 3 4 5 6 7
Quantity
-2

-4
MR
 TR curve for a firm facing a downward-sloping D
curve
20

16

Quantity P = AR TR TR
12
(units) (£) (£)
TR (£)

1 8 8
8 2 7 14
3 6 18
4 5 20
4 5 4 20
6 3 18
7 2 14
0
0 1 2 3 4 5 6 7
Quantity
 AR and MR curves for a firm facing a downward-sloping D
curve
8

Elastic
Elasticity = -1
6
AR, MR (£)

4 Inelastic

2 AR

0
1 2 3 4 5 6 7 Quantity

-2

MR
-4
 2. Costs & revenue
 Profit maximisation

 A) using total costs & total revenue

 maximising the difference between TR and TC
 total profit curve
 B) using average & marginal curves
 stage 1: profit maximised where MR = MC
 stage 2:using AR and AC curves to measure
maximum profit
• nb Normal profit - opportunity cost - cost curves
• if AR > AC, supernormal profit
 Finding maximum profit using total curves
24 TC

20

16
TR, TC, TΠ (£)

12 TR

0
1 2 3 4 5 6 7 Quantity
-4

-8 TΠ
 Finding the profit-maximising output using marginal
curves
16
MC

12
Costs and revenue (£)

4 e
Profit-maximising output

0
1 2 3 4 5 6 7
Quantity

-4 MR
 Measuring the maximum profit using average curves
16
MC

12
Costs and revenue (£)

8 AC

AR
0
1 2 3 4 5 6 7
Quantity

-4 MR
 2. Profit maximisation - qualifications

 What if a loss is made? i.e. AC > AR

 loss minimising:
still produce where MR = MC
 short-run shut-down point:
- cover variable costs, spread fixed
costs
• P = AVC

 long-run shut-down point:

• all costs are variable, thus cover LRAC
• P = LRAC