Business Objectives 3 (Revenue, Profit, Loss)

Question 1

total revenue

Answer 1

the revenue received by a firm from its sales of a good or service it is the quantity sold, multiplied by the price

TR is the area of the rectangle on a graph inside the equilibrium lines

Question 2

average revenue

Answer 2

revenue the average revenue received by the firm per unit of output; it is total revenue divided by the quantity sold

AR, is the price P0 since each unit sells for the same price – and there is one selling price: P0

D = AR because the average revenue that a firm receives for a given number of sales is equal to the price that leads to those sales

Question 3

marginal revenue

Answer 3

the additional revenue received by the firm if it sells an additional unit of output

Marginal revenue is the extra revenue received from each extra sale – MR is measured in the same units as price, and, if the demand curve is downward sloping, slopes down too

MR is steeper than the demand curve because MR is zero when PED on the demand curve is unitary

MR becomes negative when the price increases lead to lower total revenue; PED is inelastic

Question 4

Price elasticity of demand and total revenue diagram, notes

Answer 4

To the left of the midpoint PED is elastic because price decreases lead to a proportionately larger increase in quantity demanded – total revenue increases as price falls

To the right of the midpoint PED is inelastic because price decreases lead to a proportionately smaller increase in quantity demanded – total revenue decreases as price falls

TR is maximised when the firm is operating at the midpoint of the demand curve; when PED = -1

TR is maximised when MR = 0

This is the point at which extra sales reduce total revenue

Question 5

AR and MR perfectly elastic demand, notes

Answer 5

AR = MR here because each extra unit sold brings the same revenue as all the previous sales

AR is constant, so TR increases proportionately with sales

This is true for firms that are price takers

Price takers have no market power when setting prices; they accept the market clearing price because there are a large number of firms all making the same good (among other features)

Question 6

accounting profit

Answer 6

TR-TC
(not including opportunity cost in TC)

Question 7

normal profit

Answer 7

the return needed for a firm to stay in a market in the long run

Question 8

supernormal (abnormal or economic) profits

Answer 8

profits above normal profits
(include opportunity cost in TC)

Question 9

economic cost

Answer 9

total cost + opportunity cost

Question 10

profit maximisation

Answer 10

occurs at the output where MC = MR

Question 11

profit

Answer 11

TR-TC

Question 12

In terms of opportunity cost how do firms stay in the market

Answer 12

firms must make enough profit to cover their opportunity cost

If the accounting profit is lower than opportunity cost, the firm would be better off using their resources elsewhere; they would leave the market

So normal profit exactly equals opportunity cost

Question 13

Why does profit maximisation occur where MC=MR

Answer 13

1. If the marginal revenue from the next sale is greater than the marginal cost of that sale, the next sale is contributing to profits so should be made
2. If the marginal revenue from the next sale is less than the marginal cost of that sale, the next sale makes a loss so should not be made
3. Production should therefore be increased until the marginal revenue of production equals the marginal cost of production to maximise profits