Revenue & Profit (Cambridge International A-Level Economics)

Revenue

• Revenue is the income a firm receives from selling goods or services

Different types of revenue

1. Total revenue

• Total revenue is the total income received from selling output

$\mathrm{Total} \mathrm{revenue}(\mathrm{TR})=\mathrm{selling} \mathrm{price}(P)\times\mathrm{quantity} \mathrm{sold}(Q)$

• Where:

  • P = price per unit
  • Q = quantity sold

• As output increases, total revenue changes depending on price and demand conditions

2. Average revenue

• Average revenue is the revenue earned per unit of output sold

$\mathrm{Average} \mathrm{revenue}(\mathrm{AR})=\frac{\mathrm{TR}}{Q}$

• Average revenue is usually equal to the price of the good

$\mathrm{AR}=P$

• For this reason, the average revenue curve is the firm’s demand curve

3. Marginal revenue

• Marginal revenue is the additional revenue gained from selling one more unit of output

$\mathrm{Marginal} \mathrm{revenue}(\mathrm{MR})=\frac{\Delta\mathrm{in} \mathrm{TR}}{\Delta\mathrm{in}Q}$

• When price must fall to sell additional output, MR falls faster than AR
• As output increases, MR eventually becomes zero or negative

Relationship between AR and MR

• AR represents the price consumers are willing to pay
• When firms must lower price to sell more units, MR lies below the AR curve
• MR falls faster because the price reduction applies to all units sold

Worked Example Revenue calculations

Price (P)	Quantity (Q)	Total revenue (TR = P × Q)	Average revenue (AR = TR ÷ Q)	Marginal revenue (MR = ΔTR ÷ ΔQ)
8	1	8	8	8
7	2	14	7	6
6	3	18	6	4
5	4	20	5	2
4	5	20	4	0
3	6	18	3	-2

What the table shows

• Total revenue initially increases as output increases
• When marginal revenue becomes zero, total revenue is maximised
• When marginal revenue becomes negative, total revenue begins to fall
• Average revenue equals price

Profit

Types of profit

1. Supernormal profit

• Supernormal profit occurs when:

TR>TC

• This means the firm earns more than the minimum required to remain in the industry
• Firms in the market may attract new entrants
• This is also known as economic profit

2. Normal profit

• Normal profit occurs when:

TR=TC

• The firm covers all explicit and implicit costs

  • Implicit costs are the opportunity costs of production
  • Explicit costs are the costs which have to be paid e.g raw materials, wages etc.
  • Implicit costs must be considered, as entrepreneurs will rationally reallocate resources when greater profits can be made elsewhere

• The firm earns just enough to remain in the industry

3. Subnormal profit (loss)

• Subnormal profit occurs when:

TR<TC

• The firm is making a loss
• If losses persist, firms may exit the market

Worked Example Profit calculations

Output (Q)	Total revenue (TR)	Total cost (TC)	Profit (TR − TC)
5	150	90	60
6	180	96	84
7	210	210	0
8	240	260	-20

What the table shows

• Profit is maximised at Q = 6, where the difference between TR and TC is greatest
• At Q = 7, the firm earns normal profit (TR = TC)
• At Q = 8, the firm makes a subnormal profit (loss)

Revenue, costs and supernormal profit

Diagram analysis

• The diagram illustrates how firms determine profit-maximising output

• The firm maximises profit where marginal revenue equals marginal cost (MR = MC)

  • This determines the profit-maximising output level Q₁

• At this output:

  • The firm charges price P₁, determined by the AR (demand) curve
  • The firm’s average cost is C₁

• Because P₁ is greater than AC, the firm earns supernormal profit

• The shaded rectangle represents the total supernormal profit:

  • Height = P₁ − C₁
  • Width = Q₁

• If price were equal to C₁, the firm would earn normal profit

• If price were below C₁, the firm would earn subnormal profit (loss)