Revenue, Costs and Profit

Concepts

Revenue
- Marginal Revenue (MR)
- Total Revenue (TR)
- Average Revenue (AR)
- Revenue Maximization
  - TR is maximized when MR = 0
Costs
- Explicit Costs
  - Rent
  - Wages
  - Raw Materials
- Implicit Costs
  - Forgone Wages
  - Forgone Rent
  - Forgone Interest
  - Depreciation
Profit/Loss
- Accounting Profit/Loss
- Economic Profit/Loss
- Profit Maximization/Loss Minimization (MC = MR)
  - Underproduction (MR > MC)
  - Overproduction (MC > MR)
- Zero Economic Profit/Normal Profit/Breaking Even (P = ATC)
  - Economic Profit (P > ATC)
  - Economic Loss (P < ATC)

Overview

When measuring any kind of profit there are two basic things you need to know: How much revenue has been generated? and How much did it cost to produce? The additional revenue generated from selling one more unit of output is called marginal revenue (MR). Adding up the MR from each output sold is one way to calculate total revenue (TR). TR can also be calculated by multiplying P x Q. When assessing costs there are two major types that need to be considered: Explicit Costs and Implicit Costs. Explicit costs are the obvious, operational costs of running business (rent, wages, raw materials, etc.). Implicit costs are the not so obvious, opportunity costs of running a business (forgone wages, forgone interest, depreciation etc.). Accountants are primarily concerned with explicit costs. Give them receipts for operational costs, and they will save as much on taxes as they can. As a result: Accounting Profit = Total Revenue – Explicit Costs – Depreciation. Economists, on the other hand, love to over-think things. In addition to the explict costs, they also want to know what you could have been doing/earning instead. As a result: Economic Profit = Explicit Costs – Implicit Costs. Since accountants don’t subtract out as many implicit costs, accounting profit > economic profit. To maximize profit, business owners utilize marginal analysis. When the MR generated from selling a unit of output is equal to the MC of producing it, we know that profits have been maximized. Anywhere before this point and profits are not truly maximized. A firm would be underproducing because MR would be greater than MC. Anywhere after this point and a firm starts losing money. They would be overproducing because MC would be greater than MR. This decision for the best number of outputs to produce is made in real time. At the end of the day, a firm can assess if it experienced economic profit/economic loss/break even. To make this determination we compare P to ATC. If P > ATC the firm is experiencing economic profit. If P < ATC it’s experiencing economic loss. If P = ATC the firm is breaking even.

Materials

Lecture

Revenue, Costs, and Profit Lecture Video

Quiz

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