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Make sure you're comfortable with these topics first:

Costs of Production and Economies and Diseconomies of Scale

Method

Define total revenue (TR = price x quantity), average revenue (AR = TR / quantity, which equals price for a single-price firm) and marginal revenue (MR = the change in total revenue from selling one more unit).
Define total cost, average cost and marginal cost, recapping from the costs topic, and combine with revenue to define profit: profit = total revenue - total cost.
Distinguish normal profit, the minimum return needed to keep enterprise and capital in this use, counted as a cost within economic cost, from supernormal profit, any profit earned above normal profit, sometimes called abnormal or economic profit.
State the profit-maximising rule: a firm maximises profit at the output where marginal revenue equals marginal cost; at any output where MR is greater than MC, producing one more unit adds more to revenue than to cost, so it is worth producing; where MR is less than MC, the last unit cost more than it earned.
On a cost/revenue diagram, identify the profit-maximising output where MR = MC, then read the price from the demand/AR curve at that output, and shade the resulting profit or loss as the rectangle between AR and AC at that output.
Recognise that a firm might pursue objectives other than short-run profit maximisation, e.g. sales/revenue maximisation, growth maximisation, or satisficing, a useful evaluation point when a question asks whether firms 'always' maximise profit.
When calculating from a table of data, calculate MR and MC as successive differences before finding the output where they are equal, or where MR is closest to MC without MR falling below it.

Worked example

A firm faces the following data: at 4 units, total revenue is 80 pounds and total cost is 60 pounds; at 5 units, total revenue is 95 pounds and total cost is 68 pounds; at 6 units, total revenue is 108 pounds and total cost is 80 pounds. Calculate the marginal revenue and marginal cost of the 5th and 6th units, identify the profit-maximising output, and calculate the profit at that output.

Marginal revenue of the 5th unit = 95 - 80 = 15 pounds; marginal cost of the 5th unit = 68 - 60 = 8 pounds. Since MR (15) is greater than MC (8), producing the 5th unit is worthwhile.
Marginal revenue of the 6th unit = 108 - 95 = 13 pounds; marginal cost of the 6th unit = 80 - 68 = 12 pounds. Since MR (13) is still greater than MC (12), producing the 6th unit is also worthwhile.
Since MR still exceeds MC at 6 units, and no output in the data gives an exact MR = MC, the profit-maximising output in this data set is 6 units.
Calculate profit at 6 units: profit = total revenue - total cost = 108 - 80 = 28 pounds.
Confirm this is the best available output by checking profit at the other levels: at 4 units, profit = 80 - 60 = 20 pounds; at 5 units, profit = 95 - 68 = 27 pounds; at 6 units, profit = 28 pounds, so profit is indeed highest at 6 units among those given.

Practice questions

Try each question, then tap to reveal the answer.

Q1Define total revenue.Show answer

Answer: The total income a firm receives from selling its output, calculated as price multiplied by quantity sold.

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Q2What is marginal revenue?Show answer

Answer: The extra revenue a firm receives from selling one more unit of output.

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Q3Define normal profit.Show answer

Answer: The minimum profit needed to keep a firm's owners supplying their capital and enterprise to this market rather than to their next best alternative use; it is treated as a cost of production.

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Q4A firm's total revenue is 500 pounds and its total cost, including normal profit, is 420 pounds. What is its supernormal profit?Show answer

Answer: 500 - 420 = 80 pounds of supernormal profit.

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Q5A firm is producing where marginal revenue exceeds marginal cost. Explain what it should do and why.Show answer

Answer: Increase output. Each additional unit adds more to revenue than to cost, so profit rises with every extra unit until marginal cost has risen to meet marginal revenue.

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Q6If marginal revenue is 20 pounds and marginal cost is 15 pounds for the next unit, should the firm produce it? Explain.Show answer

Answer: Yes - producing that unit adds more to revenue (20 pounds) than to cost (15 pounds), so it increases total profit.

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Q7Give one objective a firm might pursue instead of short-run profit maximisation.Show answer

Answer: For example, revenue/sales maximisation, growth maximisation, or satisficing, aiming for an acceptable rather than maximum level of profit.

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Exam-style questions

Written in the style of a A Level Economics exam paper, with a full mark scheme.

Q1[5 marks]

A firm is currently producing an output at which marginal cost is 25 pounds and marginal revenue is 30 pounds. Using the MR = MC rule, explain what the firm should do to its output to maximise profit, and why.

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Tick each line you got. Your score builds from the marks on the scheme.

identifies that MR (30) currently exceeds MC (25)1 mark
states that producing more output is currently worthwhile1 mark
explains that the last unit produced added more to revenue than to cost, so producing it increased total profit1 mark
states the firm should keep expanding output until MR = MC1 mark
notes that expanding beyond the point where MR = MC would reduce profit, since further units would then cost more than they earn1 mark

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Q2[15 marks]

Evaluate the view that all firms aim to maximise profit.

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basic, undeveloped assertion, e.g. firms want money, with little reference to profit maximisation theory.2 marks
one or more developed chains, e.g. explaining the MR = MC model and/or one alternative objective, but one-sided or under-evaluated.2 marks
balanced chains covering the case for profit maximisation as the standard assumption and genuine alternative objectives, with a supported judgement.2 marks
Specific content: chain (for) - the MR = MC rule is a well-established, testable model; as long as an extra unit adds more to revenue than to cost, producing it raises profit, matching observed behaviour such as cutting unprofitable product lines.2 marks
Specific content: chain (for) - firms owned by shareholders are typically under strong pressure to maximise profit, since shareholders can otherwise sell their shares or vote out management, disciplining managers towards MR = MC.2 marks
Specific content: chain (against) - in large firms where ownership is separated from control, the principal-agent problem, managers may instead pursue sales/revenue or growth maximisation to raise their own salary, status or job security, producing beyond the profit-maximising output as long as revenue still covers costs.2 marks
Specific content: chain (against) - some firms, especially smaller or family-run businesses, may practise satisficing, an acceptable level of profit alongside other goals, rather than the theoretical maximum.1 mark
Specific content: evaluation - the answer depends on the type of firm, a small owner-managed firm is more likely to profit-maximise directly while a large public company is more exposed to the principal-agent problem, on the competitiveness of the market, and on the time period.1 mark
Specific content: judgement - a supported conclusion that profit maximisation remains the most useful default assumption for predicting firm behaviour in competitive markets, but is not universally accurate, particularly for large corporations.1 mark

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Next topics

Perfect competition, imperfectly competitive markets and monopoly Monopolistic Competition and Oligopoly: Non-Price Competition and Game Theory Alternative Business Objectives and the Principal-Agent Problem

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Revenue, Profit and the Profit-Maximising Level of Output

Before you start

Method

Worked example

Practice questions

Exam-style questions

Free printable worksheet

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