3.3.2 - Revenue, costs and profits

Total revenue is all sales income, average revenue is revenue per unit and marginal revenue is the addition to total revenue from one more unit. For a single-price firm, AR equals price and is its demand curve.

At 100 units sold for $6 each,$TR=$600 and$AR=$6. If selling unit 101 raises TR to$604, that unit's $MR=$4.

TR changes according to whether the percentage quantity response outweighs the percentage price change. On a downward-sloping linear demand curve, MR is positive in the elastic range, zero at unit elasticity and negative in the inelastic range.

In the short run at least one factor is fixed. With a constant wage per variable worker, marginal cost is inversely related to marginal product: when an extra worker adds more output, the labour cost per extra unit falls.

Initially specialisation may raise marginal product, so MC falls. Once diminishing marginal productivity begins, MP falls and MC rises. The same productivity forces help AVC become U-shaped; ATC is also U-shaped but includes AFC.

With at least one fixed factor, adding successive units of a variable factor eventually causes marginal product to fall, holding technology and the quality of inputs constant.

Early workers may specialise and use fixed capital more fully. Beyond some point, each additional worker has less fixed capital or space to work with, so the extra output from that worker declines.

When each extra input unit adds less output but still costs the same, the cost of producing an additional unit rises: diminishing returns cause the upward-sloping section of MC.

If $TFC=$500 and at 200 units $TC=$2,500, then $TVC=$2,000, $AFC=$2.50, $AVC=$10 and $AC=$12.50. If TC rises to $2,620 at 210 units,$MC=$120/10=$12 per extra unit.

In the short run at least one input and some cost are fixed, creating TFC. In the long run all inputs are variable, so the firm chooses scale and there is no fixed input in the planning decision.

LRAC shows the lowest attainable average cost for each output when all inputs and plant size can be changed. It is commonly U-shaped because scale benefits are eventually outweighed by organisational costs.

Minimum efficient scale (MES) is the lowest output at which a firm reaches the minimum point, or minimum flat range, of its long-run average cost curve and has exhausted available economies of scale.

A high MES relative to market demand favours a few large firms because entrants must achieve substantial output to match incumbents' unit costs. A low MES allows smaller firms to compete efficiently.

On an LRAC curve, move from low output along the falling section; the first output at which minimum LRAC is reached is MES. Output beyond MES does not create further scale cost savings.

Internal economies cause movement down a firm's LRAC as its own output rises. External economies lower the attainable costs of firms at each output, shifting their cost conditions downward.

As an industry concentrates or grows, workers, suppliers, infrastructure and institutions specialise around it. These shared resources can reduce LRAC for many firms without each firm expanding.

If these organisational costs grow faster than output, LRAC rises. Decentralisation, better information systems and stronger accountability may delay or reduce the problem.

Normal profit is the minimum return needed to keep enterprise in its current use and is included in economic cost. It is therefore zero economic profit, not zero accounting income.

If $AVC<AR<AC$, the firm makes a loss but continues in the short run because operating loses less than shutting immediately; it exits in the long run unless conditions improve.