Market Power Part 2: How Firms Chase Profit (And What Happens When They Don’t)

Market Power Part 2: 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 a few 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 the holy grail of firm behaviour.

Total Revenue: The Firm’s Payday

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 real-world muscle:

• 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.

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 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: 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.

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.

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

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.

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

Bonus: Economists vs Accountants

Here’s a question your IB 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.

Recap: 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 drama.

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