Business Economics · Profit maximisation under perfect competition and monopoly

Revenue and Cost Concepts for the Firm: TR, AR, MR, TC, AC and MC

Updated 11 October 2026 · Fact-checked

Total revenue is price times quantity. Average revenue is TR ÷ Q and equals price. Marginal revenue is the extra revenue from one more unit. Costs follow the same pattern: TC, AC and MC. Economic profit is revenue minus all costs, including the opportunity cost of the owner's resources. Normal profit is the minimum return that keeps the firm operating.

Understand Revenue and Cost Concepts for the Firm

A firm sells output and pays for inputs. Revenue is the money coming in. Cost is the money, and the value of resources, going out. Profit is the gap. To judge any output decision, you need to know how revenue and cost change as output changes.

Total revenue (TR) is price times quantity sold: TR = P × Q. Average revenue (AR) is TR ÷ Q, which is the same as the price per unit. So the AR curve is the firm's demand curve. Marginal revenue (MR) is the change in TR from selling one more unit: MR = ΔTR ÷ ΔQ. A firm that takes the market price (perfect competition) has MR = AR = P. A firm facing a downward-sloping demand curve must cut price to sell more, so MR is below AR.

On the cost side, total cost (TC) is fixed cost plus variable cost. Fixed cost (FC) does not change with output. Variable cost (VC) does. Average total cost (ATC or AC) is TC ÷ Q. Average variable cost (AVC) is VC ÷ Q. Average fixed cost (AFC) is FC ÷ Q and always falls as output rises. Marginal cost (MC) is the extra cost of one more unit: MC = ΔTC ÷ ΔQ. Fixed cost does not affect MC.

The short run is the period in which at least one input, such as plant size, is fixed. The long run is the period in which all inputs can be changed, so there are no fixed costs. In the short run, diminishing marginal returns make MC eventually rise. This gives U-shaped AVC and AC curves. MC cuts AVC and AC at their minimum points. When MC is below the average, the average falls. When MC is above the average, the average rises.

In economics, costs include implicit costs, such as the return the owner could have earned elsewhere. Normal profit is the return that just covers these opportunity costs. It is counted as a cost. Economic profit = TR − (explicit costs + implicit costs). It is also called supernormal or abnormal profit. When economic profit is zero, the firm earns normal profit. It is covering all costs and has no reason to leave.

Key rules to remember

Total revenue: TR = P × Q; Price times quantity sold.
Average revenue: AR = TR ÷ Q = P; Equals price, so AR is the demand curve for the firm.
Marginal revenue: MR = ΔTR ÷ ΔQ; For a price taker, MR = P. For a firm facing a downward-sloping demand curve, MR < P.
Total cost: TC = FC + VC; FC is constant in the short run. No fixed cost exists in the long run.
Average costs: AC = TC ÷ Q = AFC + AVC; AFC = FC ÷ Q and AVC = VC ÷ Q.
Marginal cost: MC = ΔTC ÷ ΔQ = ΔVC ÷ ΔQ; Fixed cost drops out because it does not change.
Economic profit: Economic profit = TR − TC, where TC includes implicit costs (normal profit); Zero economic profit means the firm earns normal profit.
MC and average relationship: MC < AC ⇒ AC falls; MC > AC ⇒ AC rises; MC = AC at minimum AC; The same holds for AVC.

How to solve Revenue and Cost Concepts for the Firm questions

Use this method for any numerical or diagram question on revenue, cost and profit.

1List the data given: price or demand function, output levels, fixed and variable costs. Note whether the question is short run or long run.
2Compute TR = P × Q at each output. If a demand function is given, write P in terms of Q first.
3Find MR as the change in TR between successive outputs. For a linear demand P = a − bQ, MR = a − 2bQ.
4Compute TC = FC + VC, then AC = TC ÷ Q, AVC = VC ÷ Q and MC = ΔTC ÷ ΔQ.
5Check whether costs are explicit only or also include implicit costs. Treat normal profit as a cost.
6Compute profit = TR − TC at each output. Compare AR with AC to see whether profit is positive, zero or negative.
7If asked about curves, use the MC rule: MC below average pulls it down, above pulls it up, and MC crosses at the minimum.
8State the answer with units and a one-line interpretation.

Quickest way: Table method with MC checks

When to use it: Use it when you get a table of output with TC or VC, or a simple demand function, and have little time.

Write columns Q, TR, TC, MR, MC in one pass.
Get MR and MC by subtracting consecutive rows. Do not divide unless the output step is not 1.
Profit = TR − TC. Pick the row with the highest value if asked.
For linear demand P = a − bQ, write MR = a − 2bQ straight away.
For curve questions, remember only that MC cuts AC and AVC at their lowest points.

Common mistakes in Revenue and Cost Concepts for the Firm

Including fixed cost when calculating MC.
Students take MC as the change in TC divided by Q rather than the change in Q.
Fix: Use MC = ΔTC ÷ ΔQ. Fixed cost does not change, so it cancels out.
Saying MR = P for every firm.
The perfect competition result is memorised without its condition.
Fix: MR = P only for a price taker. If the firm must cut price to sell more, MR is below P.
Treating zero economic profit as a loss.
Students think profit of zero means the owner earns nothing.
Fix: Zero economic profit means normal profit: all costs, including the owner's opportunity cost, are covered.
Drawing MC crossing AC at any point.
The relationship is remembered loosely.
Fix: MC must cut AC and AVC at their minimum points, rising through them from below.
Using accounting profit as economic profit.
Implicit costs, like the owner's forgone salary, are ignored.
Fix: Economic profit = accounting profit − implicit costs.
Saying there are fixed costs in the long run.
Short-run and long-run definitions are mixed up.
Fix: In the long run all inputs are variable, so all costs are variable.

Worked examples

Example 1

A firm faces demand P = 50 − 2Q. Its total cost is TC = 100 + 10Q. Find the profit-maximising output and the profit, using MR = MC.

Show the solution

TR = P × Q = 50Q − 2Q².
MR = dTR/dQ = 50 − 4Q.
MC = dTC/dQ = 10.
Set MR = MC: 50 − 4Q = 10, so Q = 10.
Price: P = 50 − 2(10) = 30.
TR = 30 × 10 = 300.
TC = 100 + 10(10) = 200.
Profit = 300 − 200 = 100.

Answer: Output is 10 units, price is 30 and profit is 100.

Example 2

A sole trader earns accounting profit of ₹6,00,000. She could earn a salary of ₹4,50,000 elsewhere and forgoes ₹50,000 of interest on the capital she invested. Find her economic profit and say what it means.

Show the solution

Implicit costs = ₹4,50,000 + ₹50,000 = ₹5,00,000.
Economic profit = accounting profit − implicit costs.
Economic profit = ₹6,00,000 − ₹5,00,000 = ₹1,00,000.
The normal profit is the ₹5,00,000 of implicit costs, which is covered.

Answer: Economic profit is ₹1,00,000. She earns more than normal profit, so she has a reason to stay.

Exam tips

Show the formula before substituting. Examiners give marks for method even if the arithmetic slips.
In MCQs, check the wording: MC uses change in total cost, not average cost.
Label axes and mark where MC crosses AC and AVC at their minima in any diagram.
State clearly whether you are answering for the short run or the long run.
When asked about normal profit, say it is included in costs and means zero economic profit.

Practice questions from Profit maximisation under perfect competition and monopoly

Revenue and Cost Concepts for the Firm in other exams

The same ground in other exams, if you are preparing for more than one or want another angle on it.

Revenue and Cost Concepts for the Firm: frequently asked questions

Why is AR the same as price?

AR is TR ÷ Q, and TR = P × Q, so AR = P. This holds for any firm selling at one price. That is why the AR curve is the demand curve.

Why does MC cut AC at its minimum?

If the extra unit costs less than the current average, the average falls. If it costs more, the average rises. So the average stops falling exactly where MC equals it, at the minimum.

What is the difference between economic profit and normal profit?

Normal profit is the minimum return needed to keep the owner in the business, and it is counted as a cost. Economic profit is what is left after all costs, including normal profit. Zero economic profit means the firm earns normal profit.

What is the difference between the short run and the long run?

In the short run at least one input is fixed, so fixed costs exist. In the long run all inputs can change, so all costs are variable and the firm can change its scale.