Supernormal Profit

To profit maximise a firm will first identify where MC = MR, which gives them Qmax, the profit-maximising quantity.

To find the Pmax, we stack it up like Dr Dre stacks his money when he’s profit maximising, all the way up to the demand or AR curve…slide across and we have our price, Pmax!

And this in itself is a huge deal: armed with just 4 curves, 2 bendy, 2 straight…entrepreneurs like Dr Dre can determine exactly what price to set to maximise their profits.

But cost & revenue diagrams just keep getting better…because they also enable entrepreneurs to see exactly how much profit they’ll make when they profit maximise.

Profit = TR – TC.

At Qmax, TR = P x Q, and is this green rectangle here! Price as the height and quantity as the width.

At Qmax, Dre’s average total cost is here, let’s call it ATC. To find Dre’s total cost, we just take his average total cost and times by quantity sold. So graphically, his average total cost is represented by this vertical line, and his quantity is represented by this horizontal line…so when we multiply the two we get this red area, Dre’s total costs!

If a firm’s total revenue is this green area, when we take away its total costs in red, we’re left with its profits as this pink area! 

TR… – TC… = profit! 

And to be more precise, these are supernormal profits because TR is higher than TC! 

To profit maximise, a firm will first identify where MC = MR, which gives them Qmax, the profit-maximising quantity.

To find the Pmax, we stack it up like Dr Dre stacks his money, all the way up to the demand or AR curve…slide across and we have our price, Pmax!

Again, slide up from Qmax, but now up to our ATC curve, and we have our ATC, call it “ATC”.

So with our price (or average revenue) up here, and our ATC here…

Profit = TR… – TC…TR is price x quantity, which gives us this green box. TC = ATC x quantity, which gives us this red box.

So TR – TC leaves us with this pink supernormal profit area here between Pmax and ATC.