Every firm you meet in this topic — tiny wheat farm or giant monopoly — is assumed to want one thing: the biggest possible profit. That single assumption gives you one rule, MC = MR, and that rule tells you where to draw the dashed line on every diagram you will ever be asked for.
📘 What you need to know
Economists count explicit costs (money actually paid out) and implicit costs (the opportunity cost of the owner’s own money, time and resources).
Profit = total revenue (TR) – total cost (TC), where TC includes both kinds of cost.
Normal profit is where TR = TC. It looks like zero, but it is exactly enough to keep the firm in this industry.
Abnormal (supernormal) profit is TR > TC. A loss is TR < TC.
Profit is maximised at the output where MC = MR.
On a diagram: find MC = MR, go up to the AR curve for price, and read AC at that same output for cost per unit.
Two kinds of cost, and why economists count both
An accountant counts the bills: wages, rent, materials, electricity. Economists call those explicit costs. But they also count what the owner gave up to run this business, which is the implicit cost.
Say you put $1m of your own savings into a bakery. An accountant records no cost for that money. An economist does: in a bank at 5% it would have earned $50,000, so $50,000 is a genuine cost of choosing the bakery. Unless the bakery beats it, you are worse off than your next best option.
Why this matters. Because implicit costs are included, “zero economic profit” is not a disaster. It means the firm is doing exactly as well as its next best alternative. That is why economists call it normal profit.
The three profit situations
TR = TC → normal profit (breakeven)
TR > TC → abnormal profit
TR < TC → loss
If a question asks why a firm stays open while “making no profit”, the answer is one sentence: it is making normal profit, so it is covering its opportunity cost and has no better option.
The profit maximisation rule
Think about one extra unit at a time. Marginal revenue (MR) is what that unit adds to revenue. Marginal cost (MC) is what it adds to cost.
If MR > MC, that unit adds more money than it costs. Make it. Profit rises.
If MC > MR, that unit costs more than it brings in. Do not make it. Profit falls.
So you keep going until the two are equal. At MC = MR there is nothing left to gain — profit is at its peak.
A common trap: students think a firm should produce where revenue is highest. It should not. Past Qmax revenue is still rising, but cost is rising faster, so profit falls.
🤔 Why “produce more” is not always the answer
Total revenue usually keeps rising as output rises, so a firm chasing revenue would produce far more than a firm chasing profit. The gap between those two targets is exactly why the MC = MR rule exists — it is the only point where you cannot make yourself better off by changing output in either direction.
Seeing it in a table of numbers
Paper 3 loves this. You are given marginal figures and asked where profit peaks. Compare the two columns line by line.
Output (units)
MR ($)
MC ($)
Effect on profit
4
40
22
+18, so make it
5
40
28
+12, so make it
6
40
40
0, the last worthwhile unit
7
40
55
-15, do not make it
Profit is maximised at 6 units. The seventh unit is not a disaster on its own, but it drags total profit down by $15, so a rational producer stops at 6.
Reading profit off a diagram
🧩 The four-step method (works for every market structure)
Find MC = MR. Mark the crossing point and drop a dashed line down to the quantity axis. That is your output.
Go straight up from that output to the AR curve and across to the price axis. That is the price the firm charges.
Read AC at the same output and go across to the axis. That is cost per unit.
Profit per unit = AR – AC. Multiply by the quantity to get total profit, and shade that rectangle.
Total profit from a diagram
total profit = (AR – AC) × Q
Step 2 is where marks disappear. Students read the price off the point where MC crosses MR. Price always comes from the AR curve, never from the MC = MR point itself.
Does profit maximisation always happen?
It is a model, so be ready to question it in an evaluation paragraph.
Firms often do not know their exact MC and MR curves, so they estimate.
Changing prices constantly annoys customers, so in the short run firms leave prices alone even when costs move.
Some firms chase market share, growth or survival first and profit later.
Owners and managers can want different things — managers may prefer a quiet life or a bigger empire.
Firms may hold prices below the profit maximising level to avoid attracting a competition regulator.
Worked examples
WORKED EXAMPLE 1
A firm’s figures are: at 5 units TR = $200 and TC = $130; at 6 units TR = $234 and TC = $156; at 7 units TR = $259 and TC = $194. Find the profit maximising output. [3]
Step 1: Profit = TR – TC at each output5 units: 200 – 130 = $706 units: 234 – 156 = $787 units: 259 – 194 = $65Step 2: Pick the biggestProfit maximising output = 6 units, profit $78Step 3: Check with the marginal rule
6th unit: MR 34 vs MC 26 → worth making. 7th unit: MR 25 vs MC 38 → not worth making.
The two methods must agree. If they do not, you have an arithmetic slip.
WORKED EXAMPLE 2
A perfectly competitive firm produces 2,000 units. AR = MR = $30, ATC = $26, AVC = $19 and MC = $30. (a) Calculate total profit. (b) Is it profit maximising? (c) Calculate total fixed cost. [5]
(a) Profit = (AR – ATC) × Q= (30 – 26) × 2,000 = 4 × 2,000Total profit = $8,000 (abnormal profit)(b) Compare MC and MRMC = $30 and MR = $30, so MC = MR → yes, it is at the profit maximising output.
(c) TFC = (ATC – AVC) × Q= (26 – 19) × 2,000 = 7 × 2,000Total fixed cost = $14,000Per-unit figures always need multiplying by Q before you call them a total.
💡 Exam tip
Write the rule as a sentence before you calculate: “profit is maximised where MC = MR”. It is often worth a mark on its own.
Label the dashed line on every diagram. An unlabelled diagram loses easy marks.
State whether the profit is normal or abnormal. Do not just give a number.
Show your working even for one step. Method marks are given for “any valid working”.
Keep units and currency signs. $8,000 and 8,000 units are not the same answer.
Save one evaluation line for “firms may not profit maximise in reality” — it fits almost any 15-mark question on this topic.
⚠ Common mix-up
Normal profit is not zero profit. It is zero economic profit, which already includes the owner’s opportunity cost.
Reading price from the MC = MR point. Go up to AR first. This is the single most common diagram error in the topic.
Confusing MR with AR. They are only the same in perfect competition. Everywhere else MR falls faster than AR.
Maximising revenue instead of profit. Revenue keeps rising past the profit peak, which is exactly the trap.
Forgetting to multiply by Q. “Profit per unit” is not “total profit”.
Ignoring implicit costs and then wondering why an “accounting profit” firm is described as breaking even.
Up next: Perfect Competition — the market where firms have no power at all, and the benchmark every other structure is judged against.
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