Revenues, costs and profits

Price maker

A firm that has to cut its price in order to sell more

Price taker

A firm that has to offer its good/services at the same price as everyone else.

It is operating in a very competitive market.

Total Revenue

Income a firm receives from selling it’s goods and services

Quantity X Price

Average revenue

Also known as the price of each unit

Total revenue/quantity

Marginal revenue

The extra revenue generated when one more unit of output is sold

Change in total revenue/change in quantity

Perfect competition

Where there is:

• Many buyers and sellers (unlimited)

• Homogeneous goods (the same)

• Firms are price takers

• No barriers to entry/exit

• Perfect information

Imperfect competition

• Fewer buyers and sellers

• Differentiated goods

• Firms are price makers

• High barriers to entry/exit

• Imperfect information

When is total revenue maximised

When MR = 0.

Anywhere point to the left along the MR curve is positive, so producing one xtra unit would increase MR. But any point on the right along MR would turn MR negative as there is no more extra rev to be gained

Profit

Total revenue - total costs

Economic profit

Considers both implicit and explicit costs

Accounting profit

Considers only explicit costs

Explicit costs

These are phyiscal costs such as TFC and TVC

Implicit costs

These are opportunity costs

Normal profit

The minimum level of profit required to keep factors of production in their current use

Supernormal (abnormal) profit

Any profit made above normal profit, an economic profit that is made positive.

Subnormal profit

An economic profit which is below normal profit, an economic loss

Normal profit on a diagram

AR = AC

Supernormal profit on a diagram

AR > AC

Subnormal profit

AR < AC

The assumption of the objective of firms in traditional economic theory

That firms are profit maximising

Reasons to profit maximise

• Re-investment (new capital, R&D etc)

• Dividends for shareholders

• Lower costs and lower prices for consumers

• Reward entrepreneurship (reward for taking the risk)

Profit maximisation on a diagram

MC = MR

If MC is greater than MR, then the firm is making less profit from producing an extra unit.

If MR is greater than MC, then the firm is underproducing, as if they produce more units they will see more revenue than costs

The point MC = MR is where NO MORE extra profit can be made from producing more

Reasons not to profit maximise

• If the firm doesn’t know their MC or MR

• To avoid scrutiny (investigation) If a firm makes very large profits, regulators may believe the firm is doing something dodgy, maybe with high prices, shortcuts with costs etc. The outcome of investigations are anti business, such as reducing prices, using more environmentally friendly methods of production

• To avoid key stakeholders being harmed

• Other objectives may be more appropriate.

Profit satisficing

Sacrificing profit to satisfy as many key stakeholders as possible

Impact of profit maximising on stakeholders

• Shareholders like it (recieve higher dividends)

• Managers (recieve higher bonus, and higher incomes)

• Consumers may dislike it (higher prices)

• Workers/ TU dislike it (lower wages from cost cutting)

• The government may dislike it (excess prices charged for consumers, low wage for workers)

• Environmental groups (pollution, waste from cutting costs)

Revenue maximisation

Occurs when MR = 0

Reasons for revenue maximisation

• Economies of scale benefits (revenue max Q is higher than Profit max Q)

• Predatory pricing (Prices are lower than Profit max, so can drive out competitors)

• Principal agent problem

Sales maximisation (growth)

AC=AR (breakeven)

Reasons for sales maximisation

• Economies of scale (Q is higher than Rmax,Pmax)

• Limit pricing (takes away the incentive for firms joining the market, limiting competitions)

• Principle agent problem

• Flood the market (lots of consumers become aware of your product, boosting loyalty)

Objectives of firms

• Profit maximisation

• Profit satisficing

• Revenue maximisation

• Sales maximisation

• Survival

Survival

A short run objective, in that period of time they can spread brand awareness, even if they are making losses, people become more aware of the product, objective can be changed

Public sector organisations

Their objective is to maximise society interest/welfare

They aim to price and produce where demand= supply (AR = MC)

Corporate social responsibility

Acting ethically