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Total revenue
Is all the money a firm earns from selling the total output of a product
TR is calculated by price x quantity sold
Average Revenue
Is total revenue divided by output ; in a single-product firm, average revenue equals the price of the product.
Average revenue = total revenue ÷ output
AR = TR ÷ Q
Marginal revenue
is the extra revenue earned from the sale of one extra unit. It is the difference between total revenue at different levels of output.
The relationship between average revenue and marginal revenue
When demand is perfectly elastic, marginal revenue = average revenue
The relationship between marginal revenue and total revenue
Marginal revenue measures the change in total revenue with respect to changes in the amount of goods and services sold. Marginal revenue is calculated by the change in total revenue divided by the change in quantity sold.
Profit
Is the difference between total revenue and total costs
Total profit = total revenue - total costs
Normal profit
The minimum reward required to keep entrepreneurs supplying their enterprise. It covers the opportunity cost of investing funds into the firms and not elsewhere. This is when the total revenue = total costs (TR = TC)
Normal profit is considered to be a cost, so it is included in the cost of production.
Supernormal profit (economic profit)
Is the profit above normal profit. This exceeds the value of opportunity cost of investing funds into the firm. This is when TR>TC.
Loss
In some circumstances, total costs of production may exceed total sales revenue, in which case there is a loss. Think of a loss as being nagative profit.
The role of profit in a market economy
In a free market economy, profit is the reward that entrepreneurs yield when they take risks and make investments.
As entrepreneurs want to avoid loss and gain profit, which makes them want to innovate, so they can reduce their production costs and improve the quality of their products. Entrepreneurs seek to maximise their profits.
Profits can be retained, so they are kept within the firm and not given to shareholders as dividends. This can be a source of finance for firms if they choose to make an investment. It helps them avoid the costs of interest payments if they borrow money.
Profits can also act as signal to firms and consumers. For example, in ,markets where firms make supernormal profits, there are likely to be new firms entering the market since the market seems profitable. This increases market supply and lowers the market price. This assumes the market is contestable and there are no barriers to entry.
Scarce economic resources generally flow where rewards to investment are higher. The factors of production are used in markets where the rate of return is higher.
