- Total Revenue (TR): This is the total income a firm receives. This will equal price × quantity
- Average Revenue (AR) = TR / Q
- Marginal Revenue (MR) = the extra revenue gained from selling an extra unit of a good
- Profit = Total revenue (TR) – Total Costs (TC) or (AR – AC) × Q
- In classical economics it is assumed that firms will seek to maximise their profits. This occurs when the difference between TR – TC is the greatest.
- Profit maximisation will also occur at an output where MR = MC
- When MR> MC the firms is increasing its profits and Total Profit is increasing.
- When MR< MC total profit starts to fall
- Therefore profit is maximised where MR = MC
Definition Normal Profit.
This occurs when TR = TC. This is the break-even point for a firm. It is the minimum profit level to keep the firm in the industry in the long run
Definition Supernormal Profit
This occurs when TR > TC
Whether To Produce at all
- If AR > ATC The firm is making supernormal profits
If AR= ATC The firm is making normal profits
- IF AR< ATC but AR > AVC. it is making an operating profit, and is
covering its variable costs. However it is making a loss because it can not cover its fixed costs as well.
- In the short run it is best to keep producing because it has already paid for its fixed costs. It is at least making a contribution to its fixed costs
- If AR <AVC The firm is likely to shut down in the short run.
Difficulties in Maximizing Profits: In the real world it is more difficult for firms to max profits because they do not have access to costs and MR easily, it is difficult to predict