Revenue, costs and profits

Introduction: Why do firms do what they do?

Welcome to one of the most practical parts of Economics! Have you ever wondered why a cinema charges so much for popcorn, or why a clothing brand suddenly has a "50% off" sale? It all comes down to Revenue, Costs, and Profits.

In this chapter, we will look at how firms make decisions. The syllabus assumes that firms are rational—which just means they have a clear goal: to make as much profit as possible. By the end of these notes, you’ll understand how they calculate their income, how costs change their behavior, and the "secret" relationship between prices and total money earned.

1. The Firm’s Main Goal: Profit Maximisation

In Economics, we usually start with a big assumption: Rational decision making. For a firm, being rational means their primary objective is profit maximisation.

What is Profit?
Think of profit as the "prize" left over after a business pays all its bills.
$ Profit = Total\ Revenue - Total\ Costs $

Why does this matter?
If a firm isn't making a profit, it can't survive in the long run. Every decision a firm makes—about what price to set or how many workers to hire—is usually aimed at making that profit "gap" as big as possible.

Quick Review: The Goal

• Rational Firms: Aim to maximise profit.
• Rational Consumers: Aim to maximise utility (satisfaction).

2. Total Revenue (TR): The Money Coming In

Total Revenue is the total amount of money a firm receives from selling its goods or services. It is not the same as profit, because we haven't subtracted the costs yet!

How to Calculate Total Revenue

The formula is very simple:
$ TR = P \times Q $

Where:
• P = Price per unit
• Q = Quantity sold

Example: If a shop sells 20 headphones for \$50 each, the Total Revenue is $ 50 \times 20 = \$1,000 $.

Common Mistake: Don't confuse Revenue with Profit. Revenue is just the cash in the till at the end of the day. Profit is what the owner actually gets to keep after paying for the electricity, the stock, and the staff!

3. Revenue and Price Elasticity of Demand (PED)

This is a favorite topic for examiners! Firms need to know if raising their prices will actually make them more money. The answer depends on the Price Elasticity of Demand (PED).

A. Elastic Demand ($ PED > 1 $)

If demand is elastic, consumers are very sensitive to price changes.
• If price rises: Many people stop buying, so Revenue falls.
• If price falls: Many more people start buying, so Revenue rises.

Analogy: Think of a luxury like a specific brand of chocolate. If the price doubles, you'll probably switch to a different brand, and the first company loses a lot of money.

B. Inelastic Demand ($ PED < 1 $)

If demand is inelastic, consumers are not very sensitive to price changes (often because it's a necessity or has no substitutes).
• If price rises: People keep buying anyway, so Revenue rises.
• If price falls: You don't get many new customers, so Revenue falls.

Example: Electricity or petrol. Even if the price goes up, you still need to turn on the lights, so the company ends up making more money.

C. Unitary Elastic Demand ($ PED = 1 $)

If demand is unitary, a change in price is exactly offset by the change in quantity sold. Total Revenue stays the same.

Memory Aid: The Revenue Tug-of-War

Imagine Price and Quantity are in a tug-of-war to decide what happens to Revenue:
• Inelastic: Price is the "strongman." Whatever Price does, Revenue follows.
• Elastic: Quantity is the "strongman." Revenue follows whatever happens to the number of sales.

4. Costs of Production: The Money Going Out

While revenue is the money coming in, Costs are the expenses a firm must pay to produce their goods. In your Unit 1 syllabus, costs are most important because they determine the Supply of a product.

Costs as a "Supply Shifter"

When the costs of production change, it shifts the entire Supply Curve:
1. Costs Increase: (e.g., higher wages, more expensive raw materials, or higher energy bills). It becomes less profitable to produce. The supply curve shifts Left (decreases).
2. Costs Decrease: (e.g., cheaper raw materials or a government subsidy). It becomes more profitable. The supply curve shifts Right (increases).

Did you know? New technology is one of the biggest ways firms lower their costs. By using a faster machine, they can make more items for the same price, shifting supply to the right!

5. Summary and Key Takeaways

Don't worry if the relationship between elasticity and revenue feels tricky—it takes a little practice! Here is the "cheat sheet" for your revision:

• The Goal: Rational firms want to maximise Profit ($ TR - TC $).
• Revenue Formula: $ Price \times Quantity $.
• Elastic Demand: Price up = Revenue DOWN. (Price and Revenue move in opposite directions).
• Inelastic Demand: Price up = Revenue UP. (Price and Revenue move in the same direction).
• Costs: If costs go up, Supply shifts left. If costs go down, Supply shifts right.

Quick Review Quiz (Mental Check!)

1. If a firm sells a product with inelastic demand, should they raise or lower the price to get more revenue? (Answer: Raise it!)
2. What happens to the supply of pizzas if the cost of cheese doubles? (Answer: Supply shifts left/decreases.)
3. True or False: Total Revenue is the same thing as Profit. (Answer: False! You must subtract costs first.)

* The content provided by thinka is generated by AI and may not always be accurate or up-to-date. Please use it as a supplementary resource and verify with official materials.