IB Economics 2.11.4 Rational Producer Behaviour Notes

In Section 2.4.3, we introduced the idea that the main goal of firms is profit maximisation:

1. At its core, profit maximisation is about finding the level of output where a firm earns the highest possible profit.
2. This happens when a firm compares its revenues and costs and adjusts its output accordingly.

We will also discover there are three types of profits firms can have:

1. Normal profit.
2. Abnormal profit.
3. Losses (negative profit).

Total profit = Total revenue - Total costs

Total revenue (TR)

Total revenue (TR) is the total amount of money earned by a firm in a period of time. It is found by using the following formula:

$$TR= P \times Q$$

where:

• $P$ = Price of the good or service.
• $Q$ = Quantity of goods (or services) sold.

Total costs (TC)

Total costs (TC) is the total expenditure incurred by a firm in the production of goods or services over a given period. It is calculated using the following formula:

$$TC=TFC+TVC$$

where:

• $TFC$ = Total Fixed Costs: costs that do not change with output (rent, salaries...)
• $TVC$ = Total Variable Costs: costs that change with output (raw materials, shipping...)

Total profit (TP)

Total profit (TP) is the total financial gain a firm makes after deducting total costs (TC) from total revenue (TR). It is calculated using the following formula:

$$TP=TR−TC$$

where:

• $TR$ = Total Revenue
• $TC$ = Total Costs

Marginal revenue (MR) = Marginal cost (MC)

Marginal revenue (MR)

Marginal revenue (MR) is the additional revenue earned from selling one more unit of output. It can be expressed by the following formula:

$$MR = \frac{\Delta TR}{\Delta Q}$$

where:

• $\Delta TR = \text{New } TR - \text{Old } TR = \text{Change in } TR$.
• $\Delta Q = \text{New } Q \text{ sold } - \text{Old } Q \text{ sold } = \text{Change in } Q \text{sold }$.

The marginal revenue curve

If the price at which a firm sells its good remains constant, regardless of its price:

1. The marginal revenue is always the same.
2. The marginal revenue equals the price.
3. This can be seen in Table 1 below.

However, if the firm increase its prices as quantities sold increase (as dictated by the supply curve):

1. The marginal revenue decreases as quantity sold increases, eventually becoming negative.
2. The marginal revenue is not equal to the price.
3. This can be seen in Table 2 below.