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Principles of Mathematical Economics-Revenue, cost and profit

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DOI: 10.13140/RG.2.2.22743.29601

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Principles of Mathematical Economics

‫اعداد‬
‫ احمد بتال‬.‫د‬.‫ا‬
‫جامعة االنبار‬-‫كلية االدارة واالقتصاد‬
Ahmed.battall@uoanbar.edu.iq
Objectives
At the end of this section you should be able
to:
● Sketch the graphs of the total revenue,
total cost, average cost and profit functions.
● Find the level of output that maximises
total revenue.
● Find the level of output that maximises
profit.
● Find the break-even levels of output
Principles of Mathematical Economics
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Profit, revenue and cost function
The profit function is denoted by the Greek letter π
(pi, pronounced ‘pie’) and is defined to be the
difference between total revenue, TR, and total cost,
TC: that is,
π = TR − TC
TR is the amount of money received by the firm
from the sale of its goods, and TC is the amount of
money that the firm has to spend to produce these
goods. We begin by considering the total revenue
and total cost functions in turn. The total revenue
received from the sale of Q goods at price P is given
by TR = PQ
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 Demand, Profit, revenue and cost function
In general, given the linear demand function
P = aQ + b (a < 0, b > 0)
the total revenue function is
TR = PQ = (aQ + b)Q
= aQ2 + bQ
This function is quadratic in Q and, since a < 0, the TR curve
has an inverted U shape

TVC, in producing Q goods is given by

TVC = (VC)Q
The total cost is the sum of the contributions from the fixed
and variable costs, so is given by
TC = FC + (VC)Q

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average cost (AC) function

AC, is obtained by dividing the total cost by output, so

that

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typical TR and TC graphs
The two curves intersect at
precisely two points, A and B,
corresponding to output levels
QA and QB.
1. At these points the cost and
revenue are equal and the
firm breaks even.
2. If Q < QA or Q > QB, then
the TC curve lies above that
of TR, so cost exceeds
revenue. For these levels of
output the firm makes a
loss.
3. If QA < Q < QB, then
revenue exceeds cost and
the firm makes a profit

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Example 1

Given the demand function

P = 100 − 2Q
express TR as a function of Q and hence sketch its graph.
(a) For what values of Q is TR zero?
(b) What is the maximum value of TR?
Solution
Total revenue is defined by
TR = PQ
and, since P = 100 − 2Q, we have
TR = (100 − 2Q)Q
= 100Q − 2Q2
This function is quadratic and so its graph can be
sketched
Principles of Mathematical Economics
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Example 1
Step 1
The coefficient of Q2 is negative, so the graph has an inverted U shape.
Step 2
The constant term is zero, so the graph crosses the TR axis at the
origin.
Step 3
To find where the curve crosses the horizontal axis, we could
use ‘the formula immediately from the factorisation
TR = (100 − 2Q)Q
that TR = 0 when either 100 − 2Q = 0 or Q = 0. In other words,
the quadratic equation
has two solutions, Q = 0 and Q = 50.
The total revenue curve is shown in Figure 2.6.

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21 ،‫ كانون الثاني‬10 University of Anbar 8
Example 1
(a) From Figure 2.6, the total revenue is zero when Q = 0 and Q = 50.
(b) By symmetry, the parabola reaches its maximum halfway between 0
and 50: that is, at Q = 25. The corresponding total revenue is given by
TR = 100(25) − 2(25)2 = 1250

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Example 2
If the fixed costs FC = 1000 and variable costs per unit VC = 4,
1-Find average cost function ?
2-graph of TC and AV ?
Solution
1- the expressions for the total and average costs
functions are
TC = 1000 + 4Q

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Example 2
2-The graph of the total cost function is easily sketched. It is a straight
line with intercept 1000 and slope 4. It is sketched in Figure 2.7.
A graph of the average cost function, based on this table, is sketched in
Figure 2.8.

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Example 3
If fixed costs are 4, variable costs per unit are 1 and the
demand function is P = 10 − 2Q
obtain an expression for π in terms of Q and hence sketch a
graph of π against Q.
(a) For what values of Q does the firm break even?
(b) What is the maximum profit?

Solution
We begin by obtaining expressions for the total
cost and total revenue. For this problem,
FC = 4 and VC = 1, so
TC = FC + (VC)Q = 4 + Q
The given demand function is P = 10 − 2Q
so TR = PQ = (10 − 2Q)Q = 10Q − 2Q2
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Example 3
Hence the profit is given by
π = TR − TC
= (10Q − 2Q2) − (4 + Q)
= 10Q − 2Q2 − 4 − Q
= −2Q2 + 9Q − 4
To sketch a graph of the profit function we follow :
Step 1
The coefficient of Q2 is negative, so the graph has an inverted U
shape.
Step 2
The constant term is −4, so the graph crosses the vertical axis when
π = −4.
Step 3
The graph crosses the horizontal axis when π = 0, so we need to
solve the quadratic equation
−2Q2 + 9Q − 4 = 0 Principles of Mathematical Economics
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Example 3
This can be done using ‘the formula’ to get

so Q = 0.5 and Q = 4.
The profit curve is sketched in Figure 2.11.
(a) From Figure 2.11 we see that profit is zero when Q = 0.5
and Q = 4.
(b) By symmetry, the parabola reaches its maximum halfway
between 0.5 and 4: that is, at
Q =1/2(0.5+4) = 2.25
The corresponding profit is given by
π = −2(2.25)2 + 9(2.25) − 4 = 6.12
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Example 3

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Homework
1. Given the demand function
P = 1000 − Q
express TR as a function of Q and hence sketch a graph of TR against Q.
What value of Q maximises total revenue, and what is the corresponding
price?

2. Given that fixed costs are 100 and that variable costs are 2 per unit,
express TC and AC as functions of Q. Hence sketch their graphs.

3. If fixed costs are 25, variable costs per unit are 2 and the demand
function is
P = 20 − Q
obtain an expression for π in terms of Q and hence sketch its graph.
(a) Find the levels of output which give a profit of 31.
(b) Find the maximum profit and the value of Q at which it is achieved.

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 Principles of Mathematical Economics
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