# ECO 105 Principles of Economic Theory Chapter 7 Revenues by act50979

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ECO 105: Principles of Economic Theory
Chapter 7: Revenues and Profit Maximization

I. The firm’s objective: profit
A. Definition of profit
1. Economic profit = total revenues - full opportunity costs of production

2. Total revenues = price x quantity

3. Full opportunity costs = explicit costs + implicit costs
Recall from Chapter 6: explicit costs are out-of-pocket expenses such as payments for labor,
raw materials, rent. Implicit costs are the opportunity costs of using resources already owned
by the firm. Normal profit is one example of an implicit cost. It is the amount of payment the
owner(s) of the firm could earn in their next-best alternative

Note: economic profit is not the same as accounting profit, since accounting profit does not
reflect implicit costs

4. An example: Ski Shop
Building: \$100,000
Inventory:\$250,000
Energy:     \$50,000
Labor: \$10,000
Income as computer programmer: \$40,000
Total Explicit costs: _________________
Full Opp. Costs:      _________________

TR = \$445,000 Y Econ profit = _____________
TR = \$450,000 Y Econ profit = _____________
TR = \$460,000 Y Econ profit = _____________

II. The firm’s output and revenue
A. Price-taking firms (farmers, stock market): Table 1
A firm is a price taker when its output
decision has no effect on market price. The
demand curve faced by the price-taking
firm is perfectly elastic at the market price.

1. In the case of price-taking firm, P = MR
= AR since the individual firm has no
effect on market price
B. Price-searching firms (fast food, clothing, cars): Table 2
A firm that has some degree of price-setting power is a price searcher. The demand curve faced
by the price-searching firm is downward sloping.

1. In the case of the price-searching firm, P
= AR > MR. MR declines as output
increases since the firm faces a
downward sloping demand curve. To
sell additional units of output, the firm
must reduce the price on all units of
output sold.

III.       The rule for maximizing profits in the short run: Tables 1 and 2
So long as an additional unit of output adds more to total revenue than it adds to total cost, total
profit will increase. This is equivalent to saying that, so long as MR > MC, producing the next unit
of output will increase profit.
A. Profit maximization and the price-taking firm

1. produce the level of output for which MR = MC

B. Profit maximization and the price-searching firm
1. produce the level of output for which MR = MC
IV. Determination of profits or losses
A. Determination of short-run economic profit
1. Economic profit = total revenue - total economic costs
2. The output decision rule for maximizing economic profit:
Produce the level of output at which MR = MC

B. To produce or not to produce
1. Positive economic profits
So long as price is greater than ATC at the profit-maximizing level of output, the firm will
earn positive economic profits.

2. The breakeven point
The price equals ATC at the profit-maximizing level of output, TR = TC and the firm’s
economic profit is 0. This price-output combination is called the breakeven point.
3. Economic losses
When price is less than ATC at the profit-maximizing level of output, the firm will incur an
economic loss. However, the decision of whether to continue operating depends on the
relationship between P and AVC.
• So long as price is greater than AVC at the level of output at which MR = MC, the firm
should continue to operate. It can cover all of its variable costs and have some money left
over to pay part of its fixed costs.

•   When price is less than AVC at the level of output at which MR = MC, the firm should
shut down. If it continues to operate, it will not be able to cover all of its variable costs,
let alone any of its fixed costs.

The price-output combination at which price equals AVC at the profit-maximizing level
of output is called the shutdown point.

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