Revenue and Profit

Revenue and Profit

Revenue
 Revenue

 Defining total, average and marginal revenue

 TR = P × Q (shown to you when we examined elasticities)
 AR = TR / Q The AR curve is the Demand Curve

(or called the Price Curve)

 MR = TR / Q so Calculated from changes in the Total Revenue curve

 Here we refer to Revenue curves when firms are price takers

 Deriving a firm’s AR and MR: price-taking firm

Price (£)

AR, MR (£)
S

Pe

D
O O
Q (millions) Q (hundreds)

(a) The market (b) The firm

 Deriving a firm’s AR and MR: price-taking firm

Price (£)

AR, MR (£)
Any individual firm is forced to
S accept the dominant, single,
market price

D = AR
Pe
5 = MR
5 10 15 = TR
D
O O 1 2 3
Q (millions) Q (hundreds)

(a) The market (b) The firm

 Total revenue for a price-taking firm
6000 Quantity Price = AR
(units) = MR (£)

0
5000
200 5
400 5
600 5
4000
800 5
TR (£)

1000 5
1200 5
3000

2000

1000

0
0 200 400 600 800 1000 1200

Quantity
 Total revenue for a price-taking firm
6000 Quantity Price = AR TR TR
(units) = MR (£) (£)

0 0
5000
200 5 1000
400 5 2000
600 5 3000
4000
800 5 4000
TR (£)

1000 5 5000
1200 5 6000
3000

2000

1000

0
0 200 400 600 800 1000 1200

Quantity
 Revenue

 Revenue curves when price varies with output

(downward-sloping demand curve)

A downward slope means different prices can be offered by
producers, and will be to entice buyers. The price can be brought
down – forced by competition - as the scale of production is
increased through economies of scale achieved by companies
AR and MR curves for a firm facing a downward-sloping demand curve
8
Q P =AR TR MR
(units) (£) (£) (£)
6 1 8 8
6
2 7 14
4
3 6 18
2
4 5 20
AR, MR (£)

4
0
5 4 20
-2
6 3 18
-4
2 7 2 14
AR

0
0.5 1 1.5 2 2.5 3 3.5 4 4.5 5 5.5 6 6.5 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) (£) (£)
6
TR (£)

1 8 8
MR= 6
8 2 7 14
3 6 18
4 5 20
5 4 20
4
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 demand curve
8
Elastic
Elasticity = -1
AR, MR (£) 6

4 Inelastic

2 AR

0
0.5 1 1.5 2 2.5 3 3.5 4 4.5 5 5.5 6 6.5 7 Quantity

-2

-4 MR
TR curve for a firm facing a downward-sloping D curve
24
Elasticity = -1
20 In
e la
s tic s tic
a
16
El

TR
12
TR (£)

0
0 1 2 3 4 5 6 7
Quantity
Revenue and Profit

Profit Maximisation
 Profit Maximisation

 Using total curves

 maximising the difference between TR & TC

 Remember what we have said about COSTS last week

 Finding maximum profit using total curves
24 TC

20

16
TR, TC, TP (£)

12 TR

0
1 2 3 4 5 6 7
Quantity
-4

-8
 Profit Maximisation

 Using total curves

 maximising the difference between TR and TC
 BUT you must remember that as economists we ASSUME that a
normal profit is part of the cost of having ‘an entrepreneur’ (s) set up
the business, so that apparently paradoxically ‘normal profit’ is part of
the COSTS, and so compounded into the AC curve.(Once again we
see that the economists is NOT an accountant)
 If TR>TC then we are really referring to ‘economic profit’ (sometimes
called ‘extra’ profit), so the expressing the urge to maximise
 Finding maximum profit using total curves
24 TC
b
20

16
TR, TC, TP (£)

12 a TR

4
c d
0
1 2 3 4 5 6 7
Quantity
-4
Ω =Economic Profit
-8 TΠ
 Finding maximum profit using total curves
24 TC

20
e
16
TR, TC, TP (£)

f TR
12

g
4

0
1 2 3 4 5 6 7
Quantity
-4

-8 TΠ
 Profit Maximisation

 We can also use marginal and average curves to find that profit
 stage 1: we derive a rule
 profit is maximised at the quantity where
MR = MC
Measuring the maximum profit using average curves
16
MC
Profits maximised at the
output where MC = MR
12

Total profit = NOTE: Price has to

Costs and revenue (£)

£1.50 x 3 = £4.50 be above AC or you

8
AC incur losses
a
6.00
TOTAL PROFIT b
4.50
4

AR
0
1 2 3 4 5 6 7 Quantity

-4 MR
Finding the profit-maximising output using marginal curves
16
MC
The key to the rule
12 MC=MR
Costs and revenue (£)

Cumulative
Marginal Marginal
4 e
profits Losses Profit-maximising
output

0
1 2 3 4 5 6 7
Quantity

-4
MR
 Profit Maximisation

 Using marginal and average curves we have seen

 stage 1:
 profit is maximised at the quantity where
MR = MC
 stage 2:
 using AR and AC curves to measure the size of the profit (and the product’s
price)
 Profit Maximisation

 How can a firm increase profit?

 boost sales (Q)
 find new markets
 product differentiation
 advertising
 impact on costs?
 use price elasticity of demand
 increase price for inelastic products
 decrease price for elastic products
 effect on TR, TC and profit in each case
 Profit Maximisation

 Some qualifications
 long-run profit maximisation
 the meaning of ‘profit’( referred to previously as ‘economic profit’)
 What if a loss is made?
 loss minimising:
 still produce where MR = MC
 Loss-minimising output
MC

AC
Costs and revenue (£)

AC
LOSS
AR

AR
O Q Quantity
MR
 The short-run shut-down point

The firm will shut

down in the short run
if it cannot cover
Costs and revenue (£)

variable costs.

If AVC is higher or
P= AC
AR lower than that
AVC
AVC shown, the firm will
shut down, it can’t
even pay wages.

AR
O Q
Quantity