Rational Producer Behavior

In microeconomics, there are a few assumptions we make in order to determine how producers should produce. Here are the ones you have to know:

(Scroll down for a concise summary if you can't be asked learning all these variables!)

Total Revenue - Total Costs (TR - TC) (AO2, AO4)

Profits = Total Revenue - Total Cost

Total Revenue (TR) refers to the value of all goods and services the firm has sold.

Total Revenue = Price x Quantity

Total Costs (TC) refers to all costs associated with supplying a good or service.

So when total revenue is subtracted by total costs, the profit of the firm is found.

Marginal Cost = Marginal Revenue (MC = MR) (AO2, AO4)

Marginal Cost = Marginal Revenue

Marginal Cost (MC) is the extra cost of producing one additional good or service.

Marginal Revenue (MR) is the extra revenue of producing one additional good or service.

When MR = MC, firms have reached their maximum profit point. This is because:

• If MC > MR, then additional costs will be higher than additional revenue, and they can produce less to earn more.

• If MC < MR, then additional revenue will be higher than additional costs, and they can produce more to earn more profit.

So firms will always produce at MC = MR!

Average Revenue and Average Costs (AR & AC) (AO2, AO4)

AR = P

Average Revenue (AR) is the same as the price of the good or service. 

AC = TC / Q

Average Costs (AC) can be calculated by dividing the total cost of production by the quantity produced. 

When AR > AC, the firm has made what is called abnormal profit. More revenue is generated than necessary to cover the expenses of production.

When AR = AC, the firm has made normal profit. Revenue just covers all expenses.

When AR < AC, the firm has made a loss. Less revenue is generated than necessary. This can happen in the short run, but is unsustainable in the long run.

"OK, so what do I actually need to remember?"

This topic may seem quite complicated, and it is. Some try to fully understand everything, others just turn to memorizing the graphs and hope for the best. This chapter is considered the hardest in the whole course.