OxfordAQA International AS and A-level Economics: Revenue, profit and technology (9640)

This guide follows the OxfordAQA International AS and A-level Economics specification (9640), version 1.2, sections 3.3.2.4 (marginal, average and total revenue curves), 3.3.2.5 (profit) and 3.3.2.6 (technological change). Section 3.3 is extra International A2 content, so it is assessed in the A2 unit on the economics of business behaviour. Quantitative skills (section 3.5) can be assessed in any unit, and the specification adds that A2 assessments need marginal values. Every firm, country and figure below is invented for illustration.

Related pages: revision notes, practice questions, the AS page on costs, scale, revenue and profit, elasticities of demand, the course hub, the printable checklist and the free 10-minute diagnostics.

What you must be able to do

Section	Outcome
3.3.2.4	Calculate marginal, average and total revenue; explain the relationship between average and marginal revenue; draw and interpret revenue curves; link marginal revenue, total revenue and price elasticity of demand
3.3.2.5	Distinguish normal from abnormal (supernormal) profit; explain why normal profit varies between industries; explain the role of profit in a market economy
3.3.2.6	Distinguish invention from innovation; analyse effects on methods, productivity, efficiency, costs, products and markets; explain links to market structure and creative destruction; weigh patents and intellectual property rights; explain the role of government and of the public and private sectors

1. Revenue: total, average and marginal

Total revenue (TR) is what the firm takes in from sales: the price times the units sold. Average revenue (AR) is takings per unit, TR divided by Q, which equals the price when every unit sells at one price. Marginal revenue (MR) is the change in TR divided by the change in Q: the revenue from one extra unit.

Worked example: a firm with market power. Marsh Lane, an invented small bakery, sells a speciality loaf with demand P = 110 − 5Q (Q in loaves a day). TR = P × Q, so at 6 loaves TR = 80 × 6 = 480.

Q	P = AR	TR	Change in TR	MR per loaf
2	100	200
4	90	360	160	80
6	80	480	120	60
8	70	560	80	40
10	60	600	40	20
12	50	600	0	0
14	40	560	−40	−20
16	30	480	−80	−40

Each MR figure is the change in TR divided by the 2 loaves added. For example, from 8 to 10 loaves: (600 − 560) ÷ 2 = 20. If demand is the line P = a − bQ, then TR = aQ − bQ² and MR = a − 2bQ. Here MR = 110 − 10Q, which agrees with the table at the mid-point of each step: at Q = 9, MR = 20.

Why MR is below AR. Move from 8 to 9 loaves. The price falls from 70 to 65. The ninth loaf brings in 65, but the first 8 now sell for 5 less each, a loss of 8 × 5 = 40. So MR = 65 − 40 = 25, which is far below the price of 65. Whenever a price cut applies to every unit sold, MR sits below AR.

Why AR is the demand curve. The demand curve pairs each quantity with the price buyers will pay for it. The firm’s revenue per unit at that quantity is exactly that price, so a graph of AR against Q is the demand curve itself.

Reading the diagram in words. Price is measured on the upward axis and quantity on the axis running across. The AR line falls from 110 on the price axis to 22 loaves on the quantity axis. The MR line leaves the price axis at that same 110, drops twice as steeply and cuts the quantity axis at 11 loaves, half of AR’s intercept. TR, on a separate diagram, is a hill that peaks at 11 loaves.

 Price
 110 +*
     |o *
     | o  *
     |  o   *
  55 +   o    *     * = AR (the demand curve)
     |    o     *   o = MR
     |     o      *
   0 +------o------*--
     0      11     22   Quantity

A price taker. Grower T, an invented tea farm, sells at 9 a kilogram whatever it supplies. At 300 kg, TR = 9 × 300 = 2,700; each extra kg adds 9. So AR = MR = price and the demand curve facing the firm is horizontal. TR rises along a ray from the origin. Selling more does not require a lower price, so earlier units lose nothing.

The link to price elasticity of demand

When MR is positive, demand is elastic and a price cut raises TR. When MR is zero, demand is unit elastic and TR is at its maximum. When MR is negative, demand is inelastic and a price cut lowers TR.

• From 6 to 8 loaves: %ΔQ = 2 ÷ 6 = +33.3% and %ΔP = −10 ÷ 80 = −12.5%. PED = 33.3 ÷ −12.5 = −2.67, elastic. TR rises from 480 to 560.
• From 14 to 16 loaves: %ΔQ = +14.3% and %ΔP = −25%. PED = −0.57, inelastic. TR falls from 560 to 480.

At a point on the curve, MR = P × (1 − 1/|PED|). At Q = 6, P = 80 and |PED| = 80 ÷ (5 × 6) = 2.67, so MR = 80 × (1 − 0.375) = 50, matching 110 − 10 × 6 = 50. A revenue-maximising firm stops where MR = 0 (Q = 11, TR = 605, P = 55). Moving down a linear demand curve, the size of PED shrinks from large to small.

2. Profit

Profit = total revenue − total costs. Suppose Marsh Lane has total costs TC = 120 + 30Q.

Q	TR	TC	Profit
4	360	240	120
6	480	300	180
8	560	360	200
10	600	420	180
11	605	450	155
12	600	480	120

Profit peaks at 8 loaves (200), yet TR peaks at 11 (605), where profit is only 155. Revenue and profit are different targets. At 8 loaves MR = 110 − 80 = 30, the same as the 30 added to cost by each extra loaf. The decision rule for profit maximisation belongs to the study of firms’ objectives, so use this only as a check here.

Normal and abnormal profit

Normal profit is the return an owner must earn to stay put rather than move to the best alternative. It equals the opportunity cost of the owner’s time and capital. Economists count it as a cost. Abnormal (supernormal) profit is profit above normal profit.

Worked example. Firm Y, an invented furniture maker, has revenue 148,000 and pays 109,000 for materials, rent and wages. The owner could earn 28,000 in a job, and 150,000 of the owner’s own savings in the business could earn 6% (9,000) elsewhere.

• Accounting profit = 148,000 − 109,000 = 39,000.
• Normal profit = 28,000 + 9,000 = 37,000.
• Abnormal profit = 39,000 − 37,000 = 2,000.

With revenue of 140,000, accounting profit is 31,000, which is 6,000 below normal. Over time the owner has a reason to close or move elsewhere.

Why normal profit varies between industries. The reward needed depends on the next best alternative and on what is risked. Compare invented figures for 400,000 of capital. A low-risk shop might need a 6% return, or 24,000. A risky venture that may lose everything might need 15%, or 60,000. Reasons:

• Higher risk needs a higher expected reward.
• Industries needing scarce skills raise the owner’s opportunity cost.
• Long waits for returns need more compensation.
• Capital that is hard to sell if the firm fails (specialist equipment) adds to risk.

The role of profit in a market economy

• Signal: high profit tells other firms that buyers value this product well above its cost.
• Incentive: the prospect of profit rewards risk-taking, enterprise and cost cutting.
• Allocation: if entry is free, resources flow towards profitable markets.
• Finance: retained profit pays for investment and research.
• Discipline: persistent losses force weak firms to change their methods or close.

Chain of reasoning: abnormal profit → new firms enter → supply rises → price falls. Suppose price falls from 14 to 10, equal to average cost including normal profit. Abnormal profit of (14 − 10) × 500 = 2,000 per firm drops to zero.

Evaluation. Profit can reflect market power or barriers to entry, so it may not signal efficiency. It can push firms to short-term thinking. It ignores external costs. How well profit allocates resources depends on how easy entry is.

3. Technological change

Invention means coming up with something new, such as a product or process. Innovation means using it commercially for the first time. A university lab that finds a cheap water filter has made an invention; the firm that first sells the filter has made an innovation.

Effects on production.

• Methods and productivity: Country A’s rice mill has 6 workers producing 1,800 bags a day (300 each). After new machinery the same workers produce 2,610 bags (435 each). Productivity rises by (435 − 300) ÷ 300 = 45%.
• Costs and efficiency: a new method may raise fixed costs and cut variable costs. Manual process: fixed cost 30,000, variable cost 8 a unit. Automated process: fixed cost 90,000, variable cost 3 a unit.

Output	Manual AC	Automated AC
8,000	11.75	14.25
12,000	10.50	10.50
20,000	9.50	7.50

The break-even output is where 30,000 + 8Q = 90,000 + 3Q, so 5Q = 60,000 and Q = 12,000. Below that, automation raises average cost. Technological change lowers costs only if output is large enough. Productive efficiency, producing at the lowest possible average cost, is moved closer when average cost falls, and investment in new methods can raise dynamic efficiency over time.

• Products and markets: new goods, new markets and new ways of selling arrive, while old markets may shrink or vanish.

Market structure. Technology can lower barriers to entry, for example when online selling removes the need for shops, so markets become more competitive. It can also raise barriers when research is costly, patents protect the innovator or the largest firm gains cost advantages, so a few firms may dominate.

Creative destruction. The term, from Schumpeter, describes new products and methods replacing old ones. Innovators earn abnormal profit for a time, imitators then enter and profit falls, while old firms and skills disappear. The gains (productivity, lower prices, new goods) are spread widely; the losses fall on identifiable firms and workers.

Patents and intellectual property rights. A patent gives the inventor a legal monopoly on the invention for a limited period.

Illustrative case. Developing a drug costs 5 million. Copying it costs 0.2 million. With a ten-year patent earning 0.9 million a year, revenue is 9 million, a net gain of 4 million. Without one, rivals copy at once, profit is competed away and the inventor loses the 5 million.

• For: the reward funds the risk and research; knowledge is published.
• Against: monopoly pricing for the patent’s life; rivals are blocked from improving the idea; legal costs; a patent may be used to stop rivals rather than to use the idea.
• Judgement: a shorter, narrower patent gives a balance between reward and competition.

Role of government. Funding research in public universities and agencies, tax relief for research, subsidies, education and training, infrastructure, patent law, and competition policy. Knowledge spills over to other firms (a positive externality), so private firms may under-invest. Risks of government failure: choosing the wrong projects and the cost to taxpayers. Invention and innovation come from both the public and private sectors: a public laboratory may do the invention and a private firm the innovation.

Common errors

• Writing MR = P for a price maker. Equality holds only when the firm is a price taker.
• Giving MR the same slope as AR on a linear demand curve.
• Treating the highest TR as the highest profit.
• Counting opportunity cost as profit, or forgetting it in the profit calculation.
• Using invention and innovation as one word.
• Saying technology always lowers average cost, with no mention of output.

Official syllabus

OxfordAQA International AS and A-level Economics (9640), version 1.2: sections 3.3.2.4, 3.3.2.5 and 3.3.2.6, with quantitative skills in section 3.5.