Revenue & Profit (Cambridge (CIE) A Level Economics): Revision Note

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

• 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

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

• 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

• 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

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

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)