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Total Revenues and Profits Revenues Total revenue is the total amount of income earned by a firm through selling goods and / or services. TR = P X Q Average revenue is a posh word for the price (since it is simply TR / Q). Marginal revenue is the revenue gained from selling one more unit. Demand curves and Total Revenue Are usually thought to be downward sloping. Total revenue can be shown by the box formed by the demand curve and the axes of a demand and supply diagram. TR, Price and PED Complete the table. Plot two graphs under one another, one showing P / Q and TR / Q Price 10 8 6 4 2 0 Quantity 0 5 10 15 20 25 TR PED Marginal Revenue If total revenue is increasing MR must be positive. If total revenue is decreasing MR must be negative. That tells us something about the value of MR when revenue is maximised – and also helps us understand how Elasticity varies along a straight demand curve. Marginal revenue and PED You know: How PED varies along the length of a demand curve. If demand is price elastic cutting the price raises total revenue (MR is positive) If demand is price inelastic cutting the price will reduce the total revenue. (MR is negative) P TR max + D=AR MR _ output Profit maximising If MR > MC then making and selling an extra good or service will increase profits. If MR < MC the firm will make a loss on that sale, reducing the profits of the business. Firms maximise profits where MR = MC. This is the law! DO NOT FORGET THIS! If a firm is maximsing profits (which we often assume they are) then they will produce at a level of output where MR = MC. Profit and Revenue maximisation MCs & MRs MC Total revenue maximisation Profit Max output MR Normal profit Normal profit is the return to the entrepreneur for risk taking. When AC=AR normal profit is being earned. When AR>AC supernormal or abnormal profit is being earned. If there is freedom of entry into an industry more firms will join in the long run. When AR<AC an economic loss is made. Either the level of profits are below normal or the firm is not even making any return for the entrepreneur. The business will close down in the long run. Revenue maximisation Firms will maximise revenue at a level of output where MR = 0. At levels of output lower than this MR is positive an extra units will add to total revenue. At levels of output higher than this MR is negative and extra units will reduce total revenue More simply Profit is maximised where TR and TC are furthest away from each other (assuming TR > TC). When this happens MR = MC! What is happening at each level of output? TC max TR & TC TR MR Output