Profit Maximization by the

Rational Producer
Unit 7 - Lesson 3
Learning Outcomes:
● Define terms in orange bold in section 7.2. (AO1)
● Explain cost, revenues and profit concepts. (AO2)
○ Total Revenue (TR), Marginal Revenue (MR) and Average Revenue (AR)
● Calculations from data of Total Revenue (TR), Marginal Revenue (MR) and
Average Revenue (AR). (AO4)
Total Revenue, Average Revenue, and Marginal Revenue
First we need to define revenue:
● Revenue is the total amount of money/payments received by a firm for selling a
certain amount of output.
○ Three type of revenue we will study:
■ Total Revenue (TR): total amount of money/payments received by a
firm for selling a certain amount of output.
● Total Revenue = Price times Quantity
■ Marginal Revenue (MR): the amount of revenue a firm receives from
selling an additional unit of output.
● Marginal Revenue = change in Total Revenue divided by change
in Quantity
■ Average Revenue (AR): amount of revenue earned per unit of output
● Average Revenue = Total Revenue divided by Quantity
Analysis of the Three Types of Revenue
The calculations of revenues for all firms is the same, however the analysis of
revenues is not all the same.

This depends on the degree to which a firm is able to control the price.

● The firm is not able to influence the price as is the case with perfectly
competitive firms.
○ These firms must accept the price the market sets - where quantity
supplied is equal to quantity demanded.
■ Therefore price is constant as output increase or decreases.
● The firm has some control over price as is the case in monopolistic
competition, monopoly and oligopoly.
○ These firms have varying degrees of price making ability.
■ Therefore price will vary with output.
Total Revenue in the case of a Price Taker
A price taking firm is a firm that does
not have price making ability.
These type of firms must accept the
price the market sets.
We know from the table on the right the
firm is a price taker and must accept
the price set by the market.
We knows this by looking at the Price of
Product (P)
The price does not change ($10) as the
output increases, therefore we know
the firm structure is perfectly
competition.
Calculating and Graphing Total Revenue
Total Revenue = Price times Output
TR = P times Q
The Total Revenue for the perfectly
competitive firm is shown in the last
column.
What do we notice?
● Since price remains constant as
output increases, total revenue
will increase at a constant rate.
○ Total Revenue increases at
a rate of $10 per each
additional unit of output.
Graphing Total Revenue - Perfect Competition
Since price does not change as output changes, total revenue will increase at a constant
rate of $10 as output increases. Therefore, the total revenue graph will be linear.
Calculating and Graphing Marginal and Average Revenue

Average Revenue = Total Revenue

divided by Quantity

● AR = TR divided by Q
○ TR (10) divided by Q (1) = 10
○ TR (20) divided by Q (2) = 10
○ TR (30) divided by Q (3) = 10
○ TR (40) divided by Q (4) = 10

Therefore since total revenue increases

at a constant rate ($10) then the average
revenue will be constant at $10
Calculating and Graphing Marginal and Average Revenue
Marginal Revenue = change in total revenue
divided by change in quantity

MR = change in TR divided by change in Q

● Change in total revenue from 1 to 2

units of output is 10 (20 minus 10)
● Change in quantity from 1 to 2 (2 minus
1) is 1.

Therefore,

● Marginal revenue = 10 divided by 1 The additional amount of revenue

● Marginal Revenue = 10 earned per additional unit of output
(MR) will remain constant at $10.
Calculating and Graphing Marginal and Average Revenue
Since Total Revenue increases at a constant rate ($10) then the additional revenue
earned per additional unit of output (MR) will be $10. For each additional unit
produced the firm will receive $10 of additional revenue - marginal revenue.
Revenue Curves for the Price Making Firms
Market structures such as monopolistic
competition, oligopoly and monopoly all have
varying degrees of price making ability.
These market structures have the ability to
set or control the price charged for a good or
service.
In the chart to the right we notice that as the
units of output increase from 0 to 6 we see
the price of the product decreases from 12 to
7.
The analysis of revenues for price making
firms will differ from the price taking firm.
Revenue Curves for the Price Making Firms
Total Revenue = Price times Output
TR = P times Q
The Total Revenue for the firms with price making
ability is shown in the last column.
What do we notice?
● As output increases from 0 to 3 units, total
revenue increases.
● As output increases 3 to 6 units, total revenue
increases at a slower rate.
● For output from 6 to 7 units, total revenue is
constant.
● For output greater than 7 units, total revenue
decreases.
Graphing Total Revenue for Price Making Firms
As output increases, total revenue will increase at an increasing rate (0 to 3) units. As
output increases from (3 to 6) units, total revenue increases at a decreasing rate. After the
7th unit of output total revenue decreases. The reasoning for this is the price elasticity of
demand (PED) discussed later.
Calculating Average Revenue
Average Revenue = Total Revenue divided
by Quantity

● AR = TR divided by Q
○ TR (12) divided by Q (1) = 12
○ TR (22) divided by Q (2) = 11
○ TR (30) divided by Q (3) = 10
○ TR (36) divided by Q (4) = 9

Therefore since total revenue increases at a

decreasing rate then the average revenue
will be decrease as output increases.
Calculating Marginal Revenue
Marginal Revenue = change in total
revenue divided by change in quantity
● From 1 to 2 units of output
○ Change in total revenue is 10
(22 minus 12)
○ Change in quantity from 1 to 2
(2 minus 1) is 1.
Therefore,
● Marginal revenue = 10 divided by 1
● Marginal Revenue = 10
Calculating Marginal Revenue
Marginal Revenue

● From 2 to 3 units of output

○ Change in total revenue is 8 (30
minus 22)
○ Change in quantity from 2 to 3
(3 minus 2) is 1.

Therefore,

● Marginal revenue = 8 divided by 1

● Marginal Revenue = 8
Calculating Marginal Revenue

Marginal Revenue

● From 3 to 4 units of output

○ Change in total revenue is 6
(36 minus 30)
○ Change in quantity from 3 to 4
(4 minus 3) is 1.

Therefore,

● Marginal revenue = 6 divided by 1

● Marginal Revenue = 6
Graphing Marginal and Average Revenue - Price Maker
As output increases and price decreases, marginal revenue falls away from average
revenue. At a price of zero marginal revenue is one half of average revenue.
(***IMPORTANT TO REMEMBER***)
Relationship TR, MR & AR for Price Making Firms
When marginal revenue is equal to zero, total revenue (42) is maximized at 7 Units of
output. Therefore, when marginal revenue equal 0, the PED for (D = AR = P) is 1. Remember
total revenue is maximized when PED is equal to 1. (***IMPORTANT TO REMEMBER***)