Define total, average and marginal revenue, state the profit-maximisation rule, and distinguish normal from supernormal profit

What this dot point is asking

SEAB wants you to define total, average and marginal revenue, state and justify the profit-maximisation rule, and distinguish normal from supernormal profit. The central insight is that a firm chooses output by the marginal rule $MR = MC$, and the level of profit it then earns depends on how average revenue compares with average cost.

The answer

Revenue concepts

• Total revenue (TR): price times quantity, $TR = P \times Q$.
• Average revenue (AR): revenue per unit, $AR = TR / Q = P$. The AR curve is therefore the firm's demand curve.
• Marginal revenue (MR): the change in total revenue from selling one more unit, $MR = \Delta TR$.

For a price taker (perfect competition), price is constant, so $AR = MR = P$ and the demand curve is horizontal. For a price maker (any firm with market power), the demand curve slopes down, so to sell more the firm must lower price on all units; MR then lies below AR and falls twice as fast for a straight-line demand curve.

The profit-maximisation rule

This is the firm-level version of the marginal principle: keep doing more while the marginal benefit (MR) exceeds the marginal cost (MC).

Normal and supernormal profit

Economists treat normal profit as a cost:

Because the resources have a next-best use elsewhere, normal profit is an opportunity cost and so is included in the firm's cost curves. This is why, at $AR = AC$, the firm still earns normal profit even though economic profit is zero.

Reading profit on the diagram

At the profit-maximising output $Q^*$ (where $MR = MC$):

• Read price (= AR) off the demand curve at $Q^*$.
• Read average cost off the AC curve at $Q^*$.
• Profit per unit is $AR - AC$; total profit is $(AR - AC) \times Q^*$, a rectangle.

Examples in context

Example 1. A tech platform with market power. A dominant app store faces a downward-sloping demand curve, so its marginal revenue is below price. It sets output and commission where $MR = MC$, and because barriers to entry let price stay above average cost, it earns large supernormal profit, the rectangle between AR and AC. This is the firm-behaviour logic behind competition concerns about big platforms.

Example 2. A hawker stall in a competitive food centre. A single stall among many close substitutes is close to a price taker: it faces near-horizontal demand, so $AR$ is close to $MR$. Easy entry competes profit down toward normal profit in the long run, so the stall covers its costs including the owner's opportunity cost but earns little economic profit, the competitive-market outcome.

Try this

Q1. State the profit-maximisation rule. [2 marks]

• Cue. Produce where marginal revenue equals marginal cost, with marginal cost rising through marginal revenue.

Q2. Explain why normal profit is treated as a cost. [3 marks]

• Cue. It is the opportunity cost of the resources, the return they could earn in their next-best use, so it must be covered to keep the firm in the industry and is included in cost.

Q3. A firm produces where $MR = MC$; at that output AR = \15$and$AC = \$15$. State its profit. [2 marks]

• Cue. It earns only normal profit (economic profit is zero), because average revenue exactly equals average cost.