Transcript Revenue Curves, Types of Profits.

Revenue curves of the business
 As a business we need to know the most profitable output
we can produce.
 To find out how we can be the most profitable we need to
understand more about the relationship between the
revenue and cost curves of the business
Revenue = Income producers receive from selling goods and
services on the market
Normal Profit for a business is where:
Profit
Total Cost =Total Revenue
TC=TR
 Profit depends on
 The price the goods are sold for
 How much is sold
Entrepreneurs include a return for
risk in their costs of production
 Cost of production
Profit = Revenue- Costs
Income from sales
this is why at TC=TR we call it
normal profit even though there
doesn’t appear to be any at all.
Includes rent wages interest
and other costs of
production
Revenue Curves
 Total Revenue (TR) = Price X Quantity of units sold
 Calculate the TR for a farmer that sells sheep at $40 each and sells 300
sheep.
 TR= 40 x 300
= $12,000
 Average Revenue (AR) is the average contribution of each unit sold to
TR. AR will be the same as price and is represented by the demand
curve
AR= TR/Q
What's the AR for the above situation?
12,000/300 = 40 = Price per sheep
 Marginal Revenue (MR) is the additional revenue the firm receives
from the sale of one more unit of output. Its calculated by the change
in TR
MR= TR2-TR1
Types of Profit
 Subnormal profit
 TR<TC
 Subnormal profit may
be sustainable in the
short-run if you are
covering variable costs
Supernormal Profit
TR>TC
Supernormal
profit will attract
other businesses
into the industry in
the Long-run.
Thus can only be
achieved in the
Short Run
Perfect Competition
Deriving the demand curve
Demand curve for the perfectly competitive firm
S
60
Price
Price
Market
60
50
50
40
40
30
30
20
20
10
10
P
D
0
D
0
1
2
3 Q4
5
6
Quantity
(million)
10 20 30 40 50 60
Output
(000)
Because the perfectly competitive firm is a price-taker it faces a horizontal
demand curve. The price is determined by demand and supply in the market.
Example revenue curves for perfectly competitive
firm
Price
($)
Quantity
Total
Revenue
Average
Revenue
Marginal
Revenue
200
60
1
60
60
60
160
60
2
120
60
60
TR
120
60
3
180
60
60
60
4
240
60
60
80
AR/MR/D
60
5
300
60
60
40
0
1
2
3
4
As a price taker, a perfectly competitive firm faces a price of $60
regardless of the amount they sell. This firm cannot affect this price in
any way.
The demand curve is horizontal. This means the firm can sell unlimited
quantities at the same price (AR=MR).
5
Cost Structures for perfect competitors
 The two most important curves to remember are the
 Marginal cost curves “the big tick”
 Average cost curves “the fruit bowl”
The marginal cost curve always cuts the AC curve at its
lowest point.
Perfectly competitive firm
P
MC
Profit
maximising
equilibrium
output is
where
MR=MC
AC
MR/AR/D
Q
 A firm will be earning
Normal Profits
normal profit when the
revenue is sufficient to cover
all the costs
 AR=AC.
 Remember the costs of
•
•
•
•
production include
Rent, paid for land
Wages paid to labour
Interest paid to capital
Profit paid for enterprise
MC
AC
AR
Normal
profit
AR=AC
Subnormal
Profit
 Where the firms costs are greater than its revenue the
firm is earning subnormal profits.
 It is quiet possible for the firm to be earning accounting
profits but because our opportunity costs may be high it
may be making an economic loss
MC
AC
AR
SUPERNORMAL PROFIT
 Where the firms costs are greater than its revenue the firm is earning subnormal
profits.
 Only a Monopolist can sustain supernormal profits in the long run.
 Perfect competitors will make normal profits in the long run, as other firms will easily
enter the market, being attracted to the supernormal profits, thus increasing supply
and resulting in normal profits
MC
AC
AR
 Making Subnormal Profits
 If, in the short run firms are making subnormal profits in a perfectly
competitive industry then in the long run some firms will exit the industry. As
firms exit the industry the market supply will decrease and consequently the
market price will increase. An increase in the market price will mean an
increase in average revenue for the remaining firms. In the long run subnormal
profits will be replaced by normal profits and only normal profits will be made
in the long-run
Making Supernormal Profits
If firms are making short-run supernormal profits in a perfectly competitive
industry then in the long- run new firms, attracted by the prospect of supernormal
profits will enter the industry. As new firms enter the industry the market supply
will increase resulting in a fall in the market price. A fall in the price will mean a
fall in average revenue for the firms. Supernormal profits will be reduced and in
the long-run only normal profits will be made.
Making Normal Profits
Perfectly competitive firms making normal profits in the short-run will continue
to do so in the. There is no incentive for firms to either exit or enter the industry.
Market supply does not change neither does the price nor average revenue.
Normal profits will continue.
Perfectly Competitive Market
Using Marginal Analysis
At Q1 MR > MC
Therefore the firm
should increase
output to gain
more profit on the
additional units of
output sold
At Q3 MC>MR,
therefore the firm
should decrease
output to avoid
making a loss on
the additional
units of output
sold
Q1
Q2
Q3
Characteristics of a Monopolist
 A monopolist firm is the only supplier of a good or service in a
market.
•The revenue curves for a monopoly are different from those of a
perfect competitor.
•The monopolist is able to restrict output so that a high price can be
charged, this means in order to sell more product the monopolist
must drop its price.
• Sound similar to the LAW OF DEMAND?
•As price decreases quantity demanded increases
•This must mean the monopolist must have a downwards sloping
demand curve!
•AR=D
Revenues for a monopolist
Price
Quantity
Total
Revenue
Average
Revenue
Marginal
Revenue
30
1
30
30
30
25
2
50
25
20
20
3
60
20
10
15
4
60
15
0
10
5
50
10
-10
5
6
30
5
-20
Revenue Curves for the Monopolist
 The AR curve is the firms demand curve
 Both the AR and MR are downwards sloping, but AR <
MR
 When TR is increasing, MR is positive
 When TR is decreasing, MR is negative
 When TR is at its maximum MR=O
Comparing Demand Curves
Perfect Competitor
Demand Curve
Degree of influence
over price
Relationship between
AR and MR
Horizontal
Price Taker
AR=MR
Monopolist
Downwards sloping
Only producer,
Price setter
MR<AR
Profit Maximising Equilibrium for the
Monopolist
 To identify the profit maximising
equilibrium position for the
monopolist firm.
 1. Find where MR=MC, from this
position draw a dashed line directly
down to horizontal axis, (Qe)
 2. Continue this dashed line
vertically till you reach the AR
curve, then take this line to the
vertical axis (Pe)
To identify AC at profit max level.
Find where the line goes vertically up from Qe and reaches the AC curve
take this then to the vertical (price axis) point c
Total supernormal profit Pe, a, b, c
Differing profit situations for the monopolist
Profit Situations
 These are assessed in the same way as perfect competitors- at
the profit maximising level of output
 If
 AR < AC
Subnormal Profits
 AR=AC
Normal Profits
 AR > AC
Supernormal Profits
What happens in the SR and LR for a Monopoly?
 In the short run, a monopoly must stay in the industry no
matter what the profits position , as at least on factor is fixed.
In the Long Run
 Earning a supernormal profit – this situation will continue
as strong barriers to entry prevent any other firms entering the
market
 Earning a normal profit – a firm will continue to operate, as it
is earning just enough profit to be worthwhile
 Earning a subnormal profit – a firm will leave the market as
better returns can be gained else where
Barriers to entry
 Barriers to entry- strategies available that will stop
new firms from entering a market
This means, existing firms will be able to keep earning supernormal
profits in the long run.
Examples of barriers to entry
 Patents – give the firm intellectual property rights over a new
invention
 Predatory pricing – policies to cut prices to a level that would force
any new entrants to operate at a loss
 Cost Advantages- resulting from economies of scale (allowing them
to undercut price)
 Spending on R&D (research and development)
 Producing a good with no close substitutes
 Advertising and marketing – competitors find it expensive to break
into the market
Monopoly VS Perfect Competition
 Compared to a perfectly competitive firm a
monopoly will
 Deliberately restrict output
 Set a price higher than MC
 Be able to earn supernormal profits in the LR.
 Not achieve the efficient level of output where AR=MR
Monopoly VS Perfect Competition
 However there are some situations where the monopolist can
provide some advantages to society
 Supernormal profits can be used to pay for R&D which could lead to
further efficiencies

If the monopolist is earning sufficient economies of scale a firm
could charge a price below that of a competitive firm.
Loss of Allocative Efficiency
Work book page 73
 In a perfectly competitive market, price is set by demand and
supply at market equilibrium, so the market is allocatively
efficient
 Curves of a monopolist
 Demand curve is downwards sloping
 MR< AR
 The monopoly restricts output to the profit maximising level
where MR=MC
Where MR=MC, the monopolist charges a higher price and lower
output than the market equilibrium where MC (S) = AR (D)
The allocative efficient level of output is where AR=MC
Deadweight loss will exist.
.
Deadweight loss (DWL) = Represents a loss of allocative efficiency
that is lost to the market
Loss of Allocative Efficiency
Government Policies and Monopolies
 Because monopolists operate at a non allocative efficient point
governments may choose to intervene in the following ways
 Price Controls
-Force the monopoly to operate at a price where
AR=MR
(called marginal cost pricing )
If costs are too high the firm may be forced into
a subnormal profit. As a result the government
may
need to subsidise the firm
- Force the monopoly to operate where AR=AC (called average cost
pricing)
The firm will then be making a normal profit and it will be
operating at a close to the allocatively efficient point.
 Remove all artificial barriers to entry for a firm – e.g legal barriers
 Encourage/legislate competition – forcing monopolies to share facilities
 Force any parts of a monopoly that can be broken up to be sold