π° Revenue Concepts
Three measures of revenue
- Total revenue (TR).
- Average revenue (AR).
- Marginal revenue (MR).
Key relationship: AR and MR
- For a price taker (perfect competition): P is constant, so AR = MR = P. Both curves are horizontal.
- For a price maker (monopoly, oligopoly): to sell more, the firm must lower its price. MR falls FASTER than AR β MR curve is below the demand (AR) curve and has twice the slope.
- When MR > 0, TR is rising; when MR = 0, TR is maximised; when MR < 0, TR is falling.
For a linear demand curve, the MR curve starts at the same intercept on the price axis but has twice the slope (gradient). It hits the quantity axis at exactly half the quantity where demand hits it.
π― Profit Maximisation: MC = MR
The golden rule: A profit-maximising firm produces where MC = MR (and MC is rising through MR). This is THE most important rule for Theory of the Firm.
Why MC = MR?
- If MR > MC: the revenue from the next unit exceeds its cost β produce it β profit rises.
- If MR < MC: the next unit costs more than it earns β don't produce it β profit would fall.
- So the optimal point is where MR = MC β the last unit just covers its cost. Any deviation reduces profit.
Reading the diagram
1. Find where MC crosses MR (from below). 2. Drop down to the Q axis β this is the profit-maximising quantity. 3. Go up to the demand (AR) curve β this is the price. 4. Compare price with ATC at that quantity to determine profit.
Price is read from the DEMAND curve, not the MC or MR curve. MC = MR tells you the quantity; the demand curve tells you the price consumers will pay for that quantity.
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π Types of Profit and the Shutdown Condition
Three profit outcomes
- Supernormal (abnormal) profit.
- Normal profit.
- Subnormal (economic) loss.
The shutdown condition
When to shut down?: In the short run, a firm should continue operating as long as P β₯ AVC (revenue covers variable costs and contributes to fixed costs). If P < AVC, the firm should shut down β it loses less by paying only FC than by continuing to produce.
- Short-run shutdown: P < AVC β shut down (losses exceed fixed costs).
- Long-run shutdown: P < ATC β exit the industry (not covering all costs).
- Short-run survival despite losses: AVC β€ P < ATC β continue operating to reduce losses.
Normal profit is a COST in economics (the opportunity cost of the entrepreneur's time and capital). So when we say AR = ATC, the firm IS making profit β just enough to stay in business.