How Firms Chase Profit

How Firms Chase Profit (And What Happens When They Don’t)

In economics, every firm is like a contestant on The Apprentice show - they’re all in it for the same thing: profit. But not everyone walks away with Lord Sugar’s approval. Some make abnormal profits, others scrape by on normal profit, and the majority crash and burn in the red zone of losses.

Let’s explain how it all works - and why that magical point where marginal cost = marginal revenue, is basically all that matters when it comes to firm behaviour.

Total Revenue: The Firm’s Payday in IB Economics

Total revenue (TR) is just the total cash a business pulls in from sales.

TR = Price × Quantity Sold

Simple enough. But let’s add some IB Economics real-life examples:

• Apple: Around 53% of its total revenue comes from iPhones.

• Microsoft: A big chunk of revenue comes from Azure cloud services (38%), followed by Office products (23%).

• Netflix: Revenue’s all about subscription fees, not DVD rentals (thankfully).

More sales = more TR. But it’s not the whole story.

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Now Let’s Talk Costs

No business runs for free - welcome to the world of costs.

Fixed Costs

These don’t change with output. Think:

• Rent on the office

• Salaries of permanent staff

• Loan repayments

Whether you sell 10 phones or 10,000, fixed costs stay the same.

Variable Costs

These change with production. Think:

• Raw materials

• Hourly wages

• Utility bills that go up when machines are running all day

Put them together:

Total Costs (TC) = Total Fixed Costs (TFC) + Total Variable Costs (TVC)

Marginal Revenue vs Marginal Cost: The IB Economics Decision Zone

This is where it gets fun (for economists, anyway).

• Marginal Revenue (MR) = the extra money earnt from selling one more unit

• Marginal Cost (MC) = the extra cost of producing one more unit

Here’s the key rule:

Profit is maximised when MR = MC

Why?

• If MR > MC → you're making extra profit from each unit. Keep going.

• If MC > MR → each extra unit costs more than it earns. Stop producing.

• If MR = MC → perfect balance. You’re at peak profitability.

Think of it as the business equivalent of Goldilocks - not too much, not too little, just right.

Abnormal Profit in IB Economics: The Sweet Spot

Also called supernormal profit or economic profit, this is when a firm earns more than just the bare minimum to survive.

Happens when AR > AC (average revenue > average cost)

This means:

• The firm is covering all its costs (including opportunity cost)

• There’s money left over as a reward for taking risk

Economists love this because it explains why firms innovate, take risks, and enter markets. No abnormal profit = no incentive.

IB Economics Real-life Examples:

• Tesla earnt huge abnormal profits on EVs once it dominated the market early on.

• Pharma companies with patents often enjoy abnormal profits for years (until generics move in).

• Start-ups dream of this - until VC funding runs dry and the bills hit.

IB Economics Normal Profit: Breakeven, But Still Breathing

This is when AR = AC.

You’re not rich, but you’re not in the red either. Economists call this zero economic profit, but it’s not “zero profit” in everyday terms - it covers all costs, just not more.

For many businesses, especially in perfect competition or monopolistic competition, this is the long-run norm. It’s enough to keep going, but not enough to buy a yacht.

Average revenue (AR) refers to the median price received from the sale of a good or service.

AR = TR / Q

Mathematically, average revenue is the same as the median price. This is because:

AR = TR / Q = ((P×Q)) / Q = P

Average cost (AC) is the cost per unit of production. It is calculated by dividing the total costs (TC) by the quantity of output (Q):

AC = TC / Q

For access to all IB Economics exam practice questions, model answers, IB Economics complete diagrams together with full explanations, and detailed assessment criteria, explore the Complete IB Economics Course:

Losses: When Things Go South

Losses happen when AR < AC, or TR < TC. That’s when you’re selling, but not earning enough to cover the bills.

Can a firm survive while making losses? Sure - in the short run. But long term? Nope. No profit means no future.

IB Economics Real-world warning signs:

• Companies cutting staff to reduce costs

• Start-ups slashing prices to compete (and bleeding cash)

• High street shops with "closing down" signs every six months

IB Economics Course Bonus: Economists vs Accountants

Here’s a question your IB Economics teacher might test you on: economists treat normal profit as a cost - because if you’re not earning at least that, there’s no reason to stay in business.

Accountants? They just look at pounds and pence, not opportunity cost.

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Recap for your IB Economics Course: Why This All Matters for Market Power

Understanding TR, TC, MR, MC, AR, AC isn’t just for graphs and diagrams. It shows us how firms behave - especially in different market structures. What matters is to understand how things work.

• In perfect competition? Firms aim to survive.

• In monopoly? They’re chasing abnormal profits.

• Everywhere in between? It’s about finding the right balance.

Next Up: Monopoly & the Dark Side of Market Power

In Part 3, we dive into monopolies - where one firm calls the shots, controls supply, and sets prices like the market’s puppet master. Get ready for some serious economic chaos.

Stay well,