Understanding Supply, Cost, and Revenue in Economics

Posted on Nov 25, 2025 in Economics

Supply Fundamentals

  1. Supply indicates the amount of a good a seller is willing and able to produce at each price point.
  2. The quantity supplied and supply are distinct concepts. The quantity supplied is the specific amount a firm is willing and able to produce at a particular price.
  3. The Law of Supply states that the quantity supplied increases as the price rises. This demonstrates a direct relationship between price and quantity supplied.
  4. Movements along the supply curve are caused exclusively by a change in the price of the good itself.
  5. Shifts (movements) of the supply curve occur when a determinant of supply changes.
  6. The key determinants of supply include:
    • Natural conditions (e.g., weather)
    • The cost of production
    • The price of other related goods
    • Expectations of future price changes

Cost Analysis and Production

  1. Total Fixed Cost (TFC) is the cost that does not vary with output. Total Variable Cost (TVC) changes as output changes. Total Cost (TC) is the sum of TFC and TVC (TC = TFC + TVC).
  2. Explicit costs are the monetary payments made during the production process. Implicit costs are the opportunity costs of owner-owned resources. Total cost is the sum of explicit and implicit costs.

  3. Key Average Costs

    • Average Fixed Cost (AFC): Total fixed cost per unit of output. AFC declines as output increases but never reaches zero.
    • Average Variable Cost (AVC): Total variable cost per unit of output.
    • Average Total Cost (ATC): Total cost per unit of output. ATC also equals the sum of AFC and AVC (ATC = AFC + AVC).
  4. Marginal Cost (MC) is the change in total cost resulting from a one-unit change in output. Since TFC does not change with output, the change in TC is equal to the change in TVC. Thus, MC is also the change in total variable cost due to a change in output.
  5. The marginal cost curve is often described as hook shaped (or U-shaped). This shape is attributed to the Law of Diminishing Returns.

  6. The Average-Marginal Relation

    This relation states:

    • If marginal cost is greater than the average cost, the average cost will rise.
    • If marginal cost is less than the average cost, the average cost will fall.

    This relationship, combined with the shape of the marginal cost curve, means that the marginal cost curve intersects the average total cost curve at the lowest point on the average total cost curve.

Revenue and Market Structure

  1. When a firm adjusts the price of its own good, it affects its own revenue and potentially the revenue of competing firms.
  2. The ability of a firm to control its own price is defined as market power.

  3. Elements of Market Structure

    Market structure refers to three organizational elements that influence a firm’s market power:

    • The number of firms in the market.
    • Freedom of entry into the market.
    • The degree to which the product is standardized (product differentiation).

  4. Market Types

    • A market characterized by many firms, free entry, and a standardized product is perfectly competitive, meaning no single firm has market power.
    • As entry becomes difficult or the product is differentiated, the number of firms is reduced, and firms gain market power.
    • When there is only one firm, blocked entry, and no acceptable substitutes, the market is a monopoly.
  5. In both perfectly competitive and monopoly markets, the revenue of one firm is generally unrelated to the revenue of another firm. In perfect competition, the lack of market power prevents a firm from changing its price significantly, thus limiting its effect on competitors. In a monopoly, there is no other firm to affect. In all other market structures, firms will have related revenues.
  6. Total Revenue (TR) is calculated as price multiplied by quantity sold. Marginal Revenue (MR) is the change in total revenue resulting from a change in output.

  7. Perfect Competition Revenue

    In perfect competition, no firm has market power, and each firm accepts the horizontal line at the market price as its demand curve. Since the market price is constant for the individual firm, when the firm sells an additional unit of output, total revenue changes exactly by the price. Therefore, marginal revenue equals the price (MR = P).

  8. Monopoly Revenue

    A monopoly must lower the price on all units sold to sell an additional unit. Marginal revenue is the extra revenue from the additional unit (its price) minus the reduction in revenue caused by lowering the price on all previous units. Consequently, the firm receives less than the price of the extra unit, meaning marginal revenue is less than price (MR < P). Since price is represented by the demand curve, the marginal revenue curve lies below the downward-sloping demand curve for a monopoly.