All Rights ReservedMicroeconomics © Oxford University Press Malaysia, 2008 8– 1.

All Rights ReservedMicroeconomics© Oxford University Press Malaysia, 2008

8– 1


8– 2

Theory of Firm8

CHAPTER


8– 3

AVERAGE REVENUE (AR) Average revenue is the total revenue per unit output sold.

Average revenue (AR) is also equal to the price (P) of the good.

Average Revenue (AR) = Total Revenue (TR)

Quantity (Q)

AR = P x Q = PRICE

Q

TOTAL REVENUE (TR) The total amount received from the sale of a firm’s goods and services.

Total Revenue (TR) = Price (P) x Quantity (Q)

CONCEPT OF REVENUE


8– 4

CONCEPT OF REVENUE

(1)Quantity

(2)Price

(3)Total Revenue

(1)X(2)

(4)Average Revenue

(3) / (1)

(4)Marginal Revenue

(3) / (1)10

20

30

40

50

60

70

50

45

40

35

30

25

20

500

900

1200

1400

1500

1500

1400

50

45

40

35

30

25

20

50

40

30

20

10

0

-10

MARGINAL REVENUE (MR) The change in total revenue resulting from one unit increase in quantity sold.

Marginal Revenue (MR) = Change in Total Revenue

Change in Quantity

MR = TR/ Q


8– 5

Quantity Price Total Revenue(TR)

Average Revenue (AR)

Marginal Revenue

(MR)10

20

30

40

50

10

9

8

7

6

100

180

240

280

300

10

9

8

7

6

10

8

6

4

2

CONCEPT OF REVENUECase I: Imperfect Market

AR equals to price but MR is less than the price when the price changes.The graph shows that AR and MR are downward sloping and MR curve lies below the AR curve.

Price

Quantity

5

10

15

0 10 20 30 40 50

AR, M

R Price

AR

MR


8– 6

Quantity Price Total Revenue(TR)

Average Revenue (AR)

Marginal Revenue

(MR)10

20

30

40

50

10

10

10

10

10

100

200

300

400

500

10

10

10

10

10

10

10

10

10

10

CONCEPT OF REVENUE (CON’T)

Case II: Perfect Market

AR, MR and price are same when the price is constant. The graph shows the horizontal line at a price of RM10 which indicates that MR = AR = Price. Quantity

5

10

15

0 10 20 30 40 50

AR, M

R Price

AR

MR


8– 7

Given demand curve as: P = a – bQ (b is the slope) TR = P x Q

= (a – bQ) x Q= aQ – bQ2

Derivation of MR from demand curveMR= dTR/dQMR= a – 2bQ (MR is ½ of the slope of DD)

CONCEPT OF REVENUE BY EQUATION


8– 8

DIFFERENCES BETWEEN ECONOMIC PROFIT AND ACCOUNTING PROFIT

8MICROECONOMICS

Economic Profit Accounting Profit

Economic profit is defined as the total revenue minus the implicit and explicit cost.

Considers explicit and implicit cost.

EC = TR – [Explicit Cost +

Implicit Cost]

Accounting profit is defined as the firm’s total revenue minus the explicit cost.

Considers only explicit cost

AC = TR – Explicit Cost


8– 9

DEFINITION OF A FIRM

A firm is an institution that buys or hires factors of production and organizes them to produce and sell goods and services.

A firm is an independent unit producing goods and services for sale.


8– 10

The main goal or objective of a firm is to maximize profit and to

minimize the cost.

OBJECTIVES OF A FIRM


8– 11

Case I: Perfect Market

TOTAL REVENUE USING THE TOTAL COST APPROACH

Using Table:Profit maximization is determined by scanning through the profit at each level, and the level which gives the highest profit is the profit maximizing output.

(1)Quantity

(Q)

(2)Price

(P)

(3)Total Revenue

(TR)

(4)Total Cost

(TC)

(5)Profit

(TR - TC)

0

1

2

3

4

5

6

7

8

9

10

300

300

300

300

300

300

300

300

300

300

300

0

300

600

900

1200

1500

1800

2100

2400

2700

3000

100

500

600

800

9500

1150

1400

2100

2700

3100

-100

-200

0

100

250

350

400

400

300

0

-100


8– 12

TR, TC

Quantity

TC

TR

Highest vertical differences

Using Graph:

TR curve is a straight line through the origin.

The maximum profit is where the vertical difference is the highest.

TOTAL REVENUE USING TOTAL COST APPROACH (CON’T)



8– 13


Case II: Imperfect Market

(1)Quantity

(Q)

(2)Price

(P)

(3)Total Revenue

(TR)

(4)Total Cost

(TC)

(5)Profit

(TR - TC)

0

1

2

3

4

5

6

7

8

9

10

340

340

330

320

310

300

290

280

270

260

240

0

340

660

960

1240

1500

1740

1960

2160

2340

2400

200

400

560

700

800

900

1040

1200

1800

2400

-200

-60

100

260

440

600

700

760

760

540

0

Using Table :Profit maximization is determined by scanning through the profit at each level, and the level which gives the highest profit is the profit maximizing output.


8– 14

TR, TC

Quantity

TC

TR

Highest vertical differences



Using Graph :

TR curve is increasing and after the profit maximizing output, the curve starts to decline.

Maximum profit is where the vertical difference between TR and TC is the highest.


8– 15


Using Table:Profit maximizing output level is obtained following the MR = MC rule.

Quantity (Q)

Price (P)

Marginal Revenue

(MR)

MarginalCost (MC)

0

1

2

3

4

5

6

7

8

9

10

300

300

300

300

300

300

300

300

300

300

300

300

300

300

300

300

300

300

300

300

300

300

400

200

100

150

200

250

450

300

400

600

700

MARGINAL REVENUE USING MARGINAL COST APPROACH


8– 16

MARGINAL REVENUE USING MARGINAL COST APPROACH (CON’T)

MR, MC

Quantity

MC

MRP*

Q*

Using Graph:

MR curve is perfectly elastic or horizontal to the price.

The profit maximization rule, MR = MC, where the MC curve intersect with the MR curve.



8– 17



Using Table:Profit maximizing output level is obtainedfollowing the MR = MC rule.

Quantity (Q)

Price (P)

Marginal Revenue

(MR)

MarginalCost (MC)

0

1

2

3

4

5

6

7

8

9

10

340

340

330

320

310

300

290

280

270

260

240

340

320

300

280

260

240

220

200

180

60

200

160

150

200

250

450

300

400

600

700


8– 18

MR, MC

Quantity

MC

MR

P*

Q*

AR=P



Using Graph:MR curve under imperfect market is downward sloping as the output increases. The profit maximization rule, MR = MC, where the MC curve intersect with the MR curve.


8– 19

TYPES OF MARKET STRUCTUREMONOPOLISTIC COMPETITION

There are large numbers of sellers and large number of buyers.

Sellers sell differentiated products due to branding and labelling,

and there are no barriers to entry and exit.

PERFECT COMPETITIONThere are a large number of

buyers and sellers, buying and selling identical product without

any restrictions on entry and exit and having perfect knowledge of

the market at a time.

MONOPOLY

There is a single seller and a large number of buyers. Sellers sell products that has no close subsitute and has a high entry

and exit barrier.

OLIGOPOLYThere are only a few firms in

the industry, but large number of buyers. Products can be

either identical or differentiated, and there are barriers to

entry and exit.

TYPES OF

MARKET

STRUCTURE

TYPES OF

MARKET

STRUCTURE


8– 20

TYPES OF MARKET STRUCTURE (CON’T)

Characteristics Perfectcompetition

Monopolistic competition

Oligopoly Monopoly

Market Structure

Type of firms Homogenous Dfferentiated Homogenous or Unique: no closedifferentiated substitutes

Conditions to Very easy Easy Significant Entry not Entry obstacles possible

Control over Price taker Price taker Independent Price maker

price

Promotion No Yes Yes Noor littlestrategy

Demand curve Horizontal Downward slope Kinked Downward slope

Number of firms Very large number Large number Few One

All Rights ReservedMicroeconomics © Oxford University Press Malaysia, 2008 8– 1.

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