A-Level Economics: Revenue and Profit PDF

REVENUE AND PROFIT A-LEVEL ECONOMICS REVENUE Revenue is the money a business makes from sales. Total revenue All of the revenue gained from selling products and services. It can be calculated as: price × output Average revenue The average of the revenue gained from selling products and service...

REVENUE AND PROFIT A-LEVEL ECONOMICS REVENUE Revenue is the money a business makes from sales. Total revenue All of the revenue gained from selling products and services. It can be calculated as: price × output Average revenue The average of the revenue gained from selling products and services. It can be calculated as: total revenue/output Marginal revenue The extra revenue gained from selling one more unit. This is the price of the last unit sold. KNOWLEDGE 11.8 What is the relationship between average revenue and price? How will total revenue be affected if there is an increase in price when demand is elastic? KNOWLEDGE 11.8 ANSWER What is the relationship between average revenue and price? How will total revenue be affected if there is an increase in price when demand is elastic? Average revenue and price are the same when a firm sells all its output at the same price. If price is increased when demand is elastic, total revenue will fall. PROFIT/LOSS Profit or loss is the difference between the total revenue and the total costs of a business. It can be calculated as: Total revenue – total costs However, economists tend to have a different understanding of the concept of profit than most businesses. This is because economists include opportunity cost as a cost of doing business. We know that opportunity cost is the cost of the next best alternative forgone. Therefore, if an entrepreneur chooses to invest in a business as opposed to saving their money in a bank then the lost interest from savings needs to be included as a business cost. THE RELATIONSHIP BETWEEN SALES & REVENUE THE RELATIONSHIP BETWEEN SALES & REVENUE Columns 1 and 2 describe the demand curve for this product, showing the quantities sold at each price. Column 3 calculates total revenue (TR) as column 1 multiplied by column 2. Marginal revenue is shown in column 4. This is calculated by taking the change in revenue between the points on the demand curve, expressed per unit. For example, if price goes from £10 to £8, the quantity sold increases from 20 to 40, and total revenue goes from £200 to £320, so revenue increases by £(320 – 200) = £120, which is £6 per unit sold. In the table the values for marginal revenue are shown halfway between the values in the other columns, as we are looking at the change between the successive points. Figure 11.8 plots these values (I have not plotted all of the negative values of MR). This shows the relationship between AR and MR. The two lines (curves) share the same intercept with the y-axis, and the MR curve is exactly twice as steep as the AR line (curve). This relationship always holds. Notice that the MR line cuts the x-axis at the quantity 60, which is the point at which TR is at a maximum. This is also a mathematical feature of the relationship. THE RELATIONSHIP BETWEEN SALES & REVENUE Figure 11.8 plots these values This shows the relationship between AR and MR. The two lines (curves) share the same intercept with the y-axis, and the MR curve is exactly twice as steep as the AR line (curve). This relationship always holds. Notice that the MR line cuts the x-axis at the quantity 60, which is the point at which TR is at a maximum. This is also a mathematical feature of the relationship. MEASURES OF PROFIT You need to be aware of three types of profit in economics: ​ Accounting profit: this is the profit made after a firm has taken away total costs (not including opportunity cost). It is this profit figure that is reported in a firm’s accounts. ​ Normal profit: this is the level of profit required to cover the total costs and the opportunity cost. In other words, it is the minimum profit needed to convince an owner to stay in the market. ​ Supernormal profit: any profit made above normal profit. Normal profit is what a business in a competitive market expects to make. It is also included in how an economist sees the total costs of a business. Therefore if a business operates where total revenue equals total costs, it makes normal profits. Any business is happy to operate at this point.