Cambridge International as and a level Economics Ebook

The firm’s revenue
In the theory of the fi rm, there are only two possible 
revenue relationships. In a competitive market, each fi rm 
has to accept the ruling market price. Its demand curve 
is horizontal, meaning that all it sells is at this one price. 
A fi rm in any other type of market will face a downward-
sloping demand curve for its product. If the fi rm chooses 
to increase its output, the extra sales will depress the price. 
To look at it another way, the sales will only increase if 
the price is reduced from its present level. An increase in 
price would lead to a fall in the volume of sales. Th
is is 
consistent with the basic principles of how markets operate 
as discussed in 
Chapter 2
. Th
e following defi nitions are 
used by economists when looking at a fi rm’s revenue:
Total revenue (TR) 
=
price × quantity
Average revenue (AR) 
=
total revenue ÷ output.
Th
e fi rm’s demand curve therefore is the average revenue line.
Marginal revenue (MR) is the addition to the total 
revenue resulting from the sale of one additional unit. 
Because the fi rm can only sell more by reducing the price, it 
follows that the value for MR will always be lower than AR.
Profits
Very simply, 
profi t
is what is left over when total costs are 
deducted from total revenue. Th
e economist’s view is rather 
wider than the view of an accountant since the latter’s 
approach does not fully recognise the full private costs of 
economic activity. As well as money paid out to factors of 
production, there must be an allowance for anything owned 
by the entrepreneur and used in the production process, 
such as any loans that may have been made to the business. 
Th
is factor cost must be estimated and included with other 
costs. As we saw in 
Chapter 1
, the idea of opportunity cost is 
relevant. Th
e entrepreneur may have capital that could have 
been used elsewhere at no risk and this would have earned 
an income. So, this cost needs to be taken into account.
Profit: 
the diff erence between total revenue and total costs.
KEY TERM
An entrepreneur, therefore, will expect a minimum level 
of profi t to refl ect what could have been earned elsewhere 
with the resources at his or her disposal. In Economics this 
is known as 
normal profi t
. It is the entrepreneur’s reward 
as a cost of production because without it, nothing would 
be produced by the fi rm. It is therefore the minimum return 
that a fi rm must receive to remain in business. So:
Profi t 
=
total revenue – total costs, including normal profi t
Normal profit: 
a cost of production that is just suff icient for 
a firm to keep operating in a particular industry.
KEY TERM
Anything above normal profi t is called