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Markets & Pricing
Revenue Concepts
• Total Revenue (TR) is defined as the total amount of
  money received by a firm from goods sold or services
  rendered during a certain time period.
• Equation: Output price X Quantity      PXQ

• Average revenue (AR) is the revenue earned per unit
  of output sold.
• Equation: Total revenue / Quantity TR/Q = P
• Marginal Revenue(MR) is revenue a firm gains in
  producing one additional unit of commodity.
• Equation: Change in total revenue/Change in
                     ∆TR/∆Q                   output.
                                                     A3 - 2
Equilibrium
• Market demand is equal to market supply
For a firm
• The price at which the quantity demanded of
  the product equals its quantity supplied is
  called its equilibrium price and the
  corresponding quantity is its equilibrium
  quantity and the firm is said to be in
  equilibrium.




                                                A3 - 3
Rule for Equilibrium
• If the production and sale of an additional unit of
  product adds more to revenue than to costs, profit
  is increased and thus that unit should be produced
  and sold. MR>MC
• If the additional unit of output involves larger costs
  than revenue, it should not be produced. MR<MC


• The firm is in equilibrium when       MR =MC


                                                           A3 - 4
Market

‘Market means the general field within which the
 forces determine the price of a particular
 commodity operate’ – Ely


A market is a body of persons in such
  commercial relations that each can easily
  acquaint himself with the rates at which
  certain kinds of exchanges of goods or
  services are from time to time made by the
  others - Sidgwick
                                                   A3 - 5
Characteristics

•   Consumers
•   Sellers
•   A Commodity
•   A Price




                                A3 - 6
Classification of Markets
•   Area: local, regional, national & international
•   Nature of transactions: spot & futures
•   Volume of transactions: whole sale & Retail
•   Time: very short , short & long period
•   Status of sellers: primary, secondary & terminal
•   Regulation: regulated & unregulated
•   Competition : perfect & imperfect



                                                       A3 - 7
Types of Markets - Competition
Type of     Nature of   No. of   No. of Entry       Price       Nature of
Market      Product     Buyers   Sellers Conditions             decision
                                                                variables
Perfect     Homogen     large    large   Free entry, Uniform    Only Output
Competiti   eous for                     free exit   every
on          all firms                                where

Simple &     “          “        One     Entry         High     Either output or
Discrimin                                barriers               price &
ating                                                           Discrimination
Monopoly                                                        in prices


Monopoli     Product    “        Many    Product       Lower    Extent of
stic        differentia                  differentio   than     product
Competiti   tion by                      n as entry    Monopo   differentiation
on          each firm                    barrier       ly       and promotion

Duopoly     Homogen Large        Two     Product       High     Competitors
            eous or                      differentiati          strategies
            differentia                  on
            ted                                                               A3 - 8
Types of Markets - Competition
Type of     Nature of     No. of   No. of Entry       Price        Nature of
Market      Product       Buyers   Sellers Conditions              decision
                                                                   variables
Oligopoly   Homogen large          A few   Product        High     Competitors
            eous or                        differentiat            strategies
            differentia                    ion
            ted

Bilateral                 One      One     Entry          Power     Output and
Monopoly Homogen                           barriers       of Seller Price
          ous                                             or Buyer

Monopso      “            “        Large   Free entry     Lowest Adjusting
ny                                                        possible output
                                                          price    according to
                                                                   price

Oligopso    Homogen       A few     “      No entry        “       Competitors
ny          eous or                        barriers                strategies
            differentia
            ted

                                                                                 A3 - 9
Monopoly


  By       A3 - 10
Introduction

• Meaning: only one firm produces and sells a
  particular commodity in the market.
• Definition: Firm and Industry coincide; the
  single firm producing the product is itself both
  the firm and the industry




                                                 A3 - 11
Main Features
•   One and only firm(Seller).
•   Single product
•   No rivals or direct competitors of the firm.
•   Indirect competition may exist.
•   No other seller can enter the market.
•   Monopolist is price maker.
•   The monopolist is rational.
•   Independent decision making
                                                   A3 - 12
Causes of Origin of Monopoly

•   Legal monopoly: Copyrights, Patents, TMs
•   Government policies: licensing
•   Natural resources
•   Exclusive knowledge of technology by the firm.
•   Public benefit or interest.
•   Price policy of the firm



                                                A3 - 13
Types

•   Legal
•   Economic
•   Natural
•   Regional




                       A3 - 14
Equilibrium
• The monopolist can control both the price and
  supply of the product. But at any point of time
  he can fix only one of them
• Equilibrium Rule: MC = MR
• The AR curve is demand curve
• Cost curves are identical of perfect market



                                                    A3 - 15
Short-Run Equilibrium -Monopoly
        Competition
                                          SMC



                                                 SAC
    Cost &Revenue




                                  P


                                  C


                                      E         AR




                                          MR



                    Units of output

                                                       A3 - 16
Long-Run Equilibrium Under
 Monopoly Competition
                                            LMC

                                                  LAC
 Price, Revenue, Cost




                                   P
                                        M




                                   E

                                                  AR & D


                                       MR



                        Quantity

                                                           A3 - 17
Price Discrimination
• The practice of discriminating among buyers on
  the basis of price charged for the same good or
  service.
• To maximise the profit the seller practices the
  discriminating price strategy based on the
  buyers income level, expectations.




                                                    A3 - 18
Prerequisites
• Market control
• Division of market
• Different price Elasticities of demand in
  different markets.




                                              A3 - 19
Bases

•   Personal
•   Geographical
•   Time
•   Purpose of use




                             A3 - 20
Oligopoly

• Oligopoly = market dominated by a few
 sellers, at least several of which are large
 enough relative to the total market that
 they can influence the market price
• Oligopoly ⇒ more intense competition
 than pure competition




                                                A3 - 21
Oligopoly

• Why Oligopolistic Behavior is So Difficult
  to Analyze
   ¤ Oligopolistic firms interact with each other
     in complex ways, and almost anything can
     and sometimes does happen under
     oligopoly.




                                                    A3 - 22
Oligopoly

• Lines of Attack:
  ¤   Ignore interdependence
  ¤   Strategic interaction
  ¤   Cartels
  ¤   Price leadership and tacit collusion
• To understand everything except first
  point, you must understand Game Theory



                                             A3 - 23
Oligopoly and Game Theory

• Game Theory analyzes problems where
 agents account for others’ actions when
 taking a decision
• Ex: duopoly – two firms serving one
 market
 ¤ Each firm supplies half of total quantity
 ¤ Choice of firm 1 affects choice of firm 2
   and vice versa

                                               A3 - 24
Monopolistic Competition,
     Oligopoly, & Public Welfare
• Behavior is so varied that it is hard to
  come to a simple conclusion about
  welfare implications.
• In many circumstances, the behavior of
  monopolistic competitors and oligopolists
  falls short of the social optimum.




                                              A3 - 25
Monopolistic Competition,
     Oligopoly, & Public Welfare
• Oligopolistic market can be perfectly
  contestable:
   ¤ If firms can enter and exit without losing
     the money they have invested
• If so, then the performance of the firms is
  likely to be close to perfectly competitive
• And thus, socially efficient


                                                  A3 - 26
Comparing the Four Market Forms

• Perfect competition and pure monopoly
  are uncommon in reality.
• Many monopolistically competitive firms
  exist.
• Oligopoly firms account for the largest
  share of the economy’s output.




                                            A3 - 27
Comparing the Four Market Forms

• Profits are zero in long-run equilibrium
  under perfect competition and
  monopolistic competition because of free
  entry and exit.
• Consequently, AC = AR = P in long-run
  equilibrium under these two market forms.




                                              A3 - 28
Comparing the Four Market Forms

• In equilibrium, MC = MR for the profit-
  maximizing firm under any market form.
• In the equilibrium of the oligopoly firm, MC
  may be unequal to MR.




                                                 A3 - 29
Comparing the Four Market Forms

• Perfectly competitive firm and industry
  theoretically ⇒ efficient allocation of
  resources.
• Monopoly and monopolistic competition
  are likely ⇒ inefficient allocation of
  resources.
• Under oligopoly, almost anything can
  happen, ⇒ impossible to generalize about
  its vices or virtues.
                                             A3 - 30
TABLE 5: Attributes of the Four
       Market Forms




               Copyright© 2006 South-Western/Thomson Learning. All rights A3 - 31
                                                                          reserved.
Perfect Competition
      Markets

           By
     Mrs. N. Jayaprada
                         32   A3 - 32
Introduction

• The concept of competition is used in two
 ways in economics.
 ¤ Competition as a process is a rivalry
   among firms.
 ¤ Competition as the perfectly competitive
   market structure.
 ¤ A perfectly competitive market is one in
   which economic forces operate unimpeded


                                         33   A3 - 33
A Perfectly Competitive Market

• A perfectly competitive market must meet
 the  The number of sellers and buyers is large.
     following requirements:
         There are no barriers to entry and exit.
   The firms’ products are identical or standardised.
       Both buyers and sellers are price takers.
  Each buyer and seller operates under conditions of
                        certainty.
             There is complete information.
              Firms are profit maximizers.
        Each firm takes its independent action.
       Perfect mobility of factors of production
                                                    A3 - 34
The Competitive Industry and
                               Firm typical firm can sell
   1.The intersection of the market 3.The
     supply and the market demand        all it wants at the
                curve…                    market price…
  Price       Market              Price             Firm
per unit                        per unit
                       S


  35                                 35
                                                            Demand
                                                               Curve
                            D                             Facing the
                                                                Firm

            Units of output                     Units of output
        2.determine the                    4.so it faces a
       equilibrium market                 horizontal demand
              price                             curve
                                                                  35   A3 - 35
Goals and Constraints of the
      Competitive Firm
• Perfectly competitive firm faces
 a cost constraint like any other
 firm
• Cost of producing any given
 level of output depends on
  ¤ Firm’s production technology
  ¤ Prices it must pay for its inputs

                                        36   A3 - 36
Costs Relevant to a Firm
P=MR= AR   Output   Total cost   Marginal    Average      Total    Profit
                                  Cost      Total Cost   Revenue   TR-TC

             0        40.00         -           -           0      -40.00
  35.00      1        68.00       28.00       68.00       35.00    -33.00
  35.00      2        88.00       20.00       44.00       70.00    -18.00
  35.00      3       104.00       16.00       34.67      105.00     1.00
  35.00      4       118.00       14.00       29.50      140.00    22.00
  35.00      5       130.00       12.00       26.00      175.00    45.00
  35.00      6       147.00       17.00       24.50      210.00    63.00
  35.00      7       169.00       22.00       24.14      245.00    76.00
  35.00      8       199.00       30.00       24.88      280.00    81.00
  35.00      9       239.00       40.00       26.56      315.00    76.00
  35.00      10      293.00       54.00       29.30      350.00    57.00
                                                                     A3 - 37
Profit Determination Using
                       Total Cost and Revenue
                                Curves      TC                         TR
                       385                           Loss
                       350
Total cost, revenue




                       315    Maximum profit =81
                                                                  Profit
                       280
                       245
                       210   130
                       175
                       140
                       105                         Profit =45
                        70
                        35         Loss
                         0
                             1 2 3 4 5 6 7 8 9                  Quantity

                                                                            A3 - 38
Marginal Cost, Marginal Revenue,
             and Price
                                                             MC
                                 Costs
Price = MR Quantity   Marginal
          Produced     Cost
    35.00 0                        60
                        28.00
   35.00 1                         50
                       20.00
   35.00 2
                       16.00
   35.00 3                         40            A       C
                       14.00                                    P = AR = MR
   35.00 4                                               B
                       12.00       30                A
   35.00 5
                       17.00
   35.00 6             22.00       20
   35.00 7             30.00
   35.00 8                         10
                       40.00
   35.00 9             54.00        0
   35.00 10            68.00             1 2 3 4 5 6 7 8 9 10   Quantity


                                                                           A3 - 39
Short run Equilibrium

• Depending upon the positions of the short
 run cost curves, in short run, individual
 firm can make
• Super normal profits
• Normal profits
• Losses


                                             40   A3 - 40
Determining Profits Graphically

Price                  MC      Price                  MC      Price                   MC
   65                            65                             65
   60                            60                             60
   55                            55                             55
   50                            50                             50                    ATC
   45                            45                   ATC       45
   40 D           A P = MR=AR40                                 40     Loss          P=MR=AR
   35                            35                             35
   30 Profit                     30                P = MR=AR 30
                    B ATC
   25 C                          25                             25
   20             E              20                             20
   15                            15                             15
   10                            10                             10
    5                              5                             5
    0 1 2 3 4 5 6 7 8 910 12       0 1 2 3 4 5 6 7 8 910 12       0 1 2 3 4 5 6 7 8 910 12
             Quantity                      Quantity                       Quantity
(a) Super Profit case     (b) Normal profit case            (c) Loss case

                                                                                     A3 - 41
Determining Profit and Loss From
            a Graph
• Find output where MC = MR.
  ¤   The intersection of MC = MR (P)
      determines the quantity the firm will
      produce if it wishes to maximize profits.
   Find   profit per unit where MC = MR .
      Drop a line down from where MC equals
      MR, and then to the ATC curve.
      This is the profit per unit.
      Extend a line back to the vertical axis to
      identify total profit.                       A3 - 42
Determining Profit and Loss From
               a Graph
• The firm makes a super profit when the ATC
 curve is below the MR curve.
• The firm makes a normal profit when the ATC
 curve is equal to the MR curve.
• The firm incurs a loss when the ATC curve is
 above the MR curve.




                                                 A3 - 43
Special case: Exit / Shutdown
• The shutdown point Pointpoint at which the
                     is the
  firm will be better off it shuts down than it will if
  it stays in business.
• If total revenue is more than total variable cost,
  the firm’s best strategy is to temporarily
  produce at a loss.
• It is taking less of a loss than it would by
  shutting down.

     Condition I – Price < AVC – Shut down
     Condition II – Price >= AVC – Continue
                                                      A3 - 44
The Shutdown Decision
                             MC
Price
  60
  50                          ATC

  40        Loss
  30                       P = MR=AR
                             AVC
  20
                   A
  10
   0    2          6
            4          8     Quantity

                                        A3 - 45
Long-Run Competitive Equilibrium

• Profits and losses are inconsistent with
  long-run equilibrium.
   ¤ Profits create incentives for new firms to
     enter, output will increase, and the price
     will fall until zero profits are made.
   ¤ The existence of losses will cause firms to
     leave the industry.
   ¤ In the long-run equilibrium of a competitive
     industry, all firms make normal profits.

                                                    A3 - 46
Long-Run Competitive Equilibrium
                                        MC
Price
   60           P=MR=AR=SAC=SMC=LAC

   50
                                      SRATC LRATC
   40
   30                           P = MR=AR

   20
   10
    0   2   4     6      8       Quantity


                                                    A3 - 47
Price Determination in a Perfectly
      Competitive Industry
• In the short run, the price does more of
  the adjusting.
• In the long run, more of the adjustment is
  done by quantity.




                                               A3 - 48
Price Determination in a Perfectly
                      Competitive Industry
     Price Determination in Market Period (very short run)

                         s            • Supply of the
                   D’
                  D
                                        commodity is fixed as
Price of Good




      P’                 E’             inputs are fixed in
                  D”
       P                 E              supply.
      X




      P”                 E”
                                 D’
                                      • Demand changes Price
                                D       and Equilibrium points
                               D”
                                        also change
                                        accordingly.
                Quantity of Good X



                                                                 A3 - 49
Price Determination in a Perfectly
                      Competitive Industry
     Price Determination in short run

                                                     • Supply of the
                           D’           s
                                                       commodity changes as
Price of Good




                          D                            variable factors can be
       P’                              E’              changed but scale of
      X




                     D”                                plant is not possible.
        P                          E            D’
       P”                     E”                     • Demand changes Price
                                            D
                s                      D”
                                                       and Equilibrium points
                                                       also change
                    Quantity of Good X
                                                       accordingly.


                                                                                A3 - 50
Price Determination in a Perfectly
                      Competitive Industry
     Price Determination in Long Run

                                            • Supply of the
                        D                     commodity fully
                                       LP
Price of Good




                   D’                  S      adjusted to meet the
       P’                        E’           changes in the industry
      X




         P                   E
                                              as scale of plant is
                        E”
                                              possible.
                                       D
                                  D’        • Supply changes Price
                                              and Equilibrium points
                Quantity of Good X
                                              also change
                                              accordingly.

                                                                       A3 - 51

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Markets me vi unit

  • 2. Revenue Concepts • Total Revenue (TR) is defined as the total amount of money received by a firm from goods sold or services rendered during a certain time period. • Equation: Output price X Quantity PXQ • Average revenue (AR) is the revenue earned per unit of output sold. • Equation: Total revenue / Quantity TR/Q = P • Marginal Revenue(MR) is revenue a firm gains in producing one additional unit of commodity. • Equation: Change in total revenue/Change in ∆TR/∆Q output. A3 - 2
  • 3. Equilibrium • Market demand is equal to market supply For a firm • The price at which the quantity demanded of the product equals its quantity supplied is called its equilibrium price and the corresponding quantity is its equilibrium quantity and the firm is said to be in equilibrium. A3 - 3
  • 4. Rule for Equilibrium • If the production and sale of an additional unit of product adds more to revenue than to costs, profit is increased and thus that unit should be produced and sold. MR>MC • If the additional unit of output involves larger costs than revenue, it should not be produced. MR<MC • The firm is in equilibrium when MR =MC A3 - 4
  • 5. Market ‘Market means the general field within which the forces determine the price of a particular commodity operate’ – Ely A market is a body of persons in such commercial relations that each can easily acquaint himself with the rates at which certain kinds of exchanges of goods or services are from time to time made by the others - Sidgwick A3 - 5
  • 6. Characteristics • Consumers • Sellers • A Commodity • A Price A3 - 6
  • 7. Classification of Markets • Area: local, regional, national & international • Nature of transactions: spot & futures • Volume of transactions: whole sale & Retail • Time: very short , short & long period • Status of sellers: primary, secondary & terminal • Regulation: regulated & unregulated • Competition : perfect & imperfect A3 - 7
  • 8. Types of Markets - Competition Type of Nature of No. of No. of Entry Price Nature of Market Product Buyers Sellers Conditions decision variables Perfect Homogen large large Free entry, Uniform Only Output Competiti eous for free exit every on all firms where Simple & “ “ One Entry High Either output or Discrimin barriers price & ating Discrimination Monopoly in prices Monopoli Product “ Many Product Lower Extent of stic differentia differentio than product Competiti tion by n as entry Monopo differentiation on each firm barrier ly and promotion Duopoly Homogen Large Two Product High Competitors eous or differentiati strategies differentia on ted A3 - 8
  • 9. Types of Markets - Competition Type of Nature of No. of No. of Entry Price Nature of Market Product Buyers Sellers Conditions decision variables Oligopoly Homogen large A few Product High Competitors eous or differentiat strategies differentia ion ted Bilateral One One Entry Power Output and Monopoly Homogen barriers of Seller Price ous or Buyer Monopso “ “ Large Free entry Lowest Adjusting ny possible output price according to price Oligopso Homogen A few “ No entry “ Competitors ny eous or barriers strategies differentia ted A3 - 9
  • 10. Monopoly By A3 - 10
  • 11. Introduction • Meaning: only one firm produces and sells a particular commodity in the market. • Definition: Firm and Industry coincide; the single firm producing the product is itself both the firm and the industry A3 - 11
  • 12. Main Features • One and only firm(Seller). • Single product • No rivals or direct competitors of the firm. • Indirect competition may exist. • No other seller can enter the market. • Monopolist is price maker. • The monopolist is rational. • Independent decision making A3 - 12
  • 13. Causes of Origin of Monopoly • Legal monopoly: Copyrights, Patents, TMs • Government policies: licensing • Natural resources • Exclusive knowledge of technology by the firm. • Public benefit or interest. • Price policy of the firm A3 - 13
  • 14. Types • Legal • Economic • Natural • Regional A3 - 14
  • 15. Equilibrium • The monopolist can control both the price and supply of the product. But at any point of time he can fix only one of them • Equilibrium Rule: MC = MR • The AR curve is demand curve • Cost curves are identical of perfect market A3 - 15
  • 16. Short-Run Equilibrium -Monopoly Competition SMC SAC Cost &Revenue P C E AR MR Units of output A3 - 16
  • 17. Long-Run Equilibrium Under Monopoly Competition LMC LAC Price, Revenue, Cost P M E AR & D MR Quantity A3 - 17
  • 18. Price Discrimination • The practice of discriminating among buyers on the basis of price charged for the same good or service. • To maximise the profit the seller practices the discriminating price strategy based on the buyers income level, expectations. A3 - 18
  • 19. Prerequisites • Market control • Division of market • Different price Elasticities of demand in different markets. A3 - 19
  • 20. Bases • Personal • Geographical • Time • Purpose of use A3 - 20
  • 21. Oligopoly • Oligopoly = market dominated by a few sellers, at least several of which are large enough relative to the total market that they can influence the market price • Oligopoly ⇒ more intense competition than pure competition A3 - 21
  • 22. Oligopoly • Why Oligopolistic Behavior is So Difficult to Analyze ¤ Oligopolistic firms interact with each other in complex ways, and almost anything can and sometimes does happen under oligopoly. A3 - 22
  • 23. Oligopoly • Lines of Attack: ¤ Ignore interdependence ¤ Strategic interaction ¤ Cartels ¤ Price leadership and tacit collusion • To understand everything except first point, you must understand Game Theory A3 - 23
  • 24. Oligopoly and Game Theory • Game Theory analyzes problems where agents account for others’ actions when taking a decision • Ex: duopoly – two firms serving one market ¤ Each firm supplies half of total quantity ¤ Choice of firm 1 affects choice of firm 2 and vice versa A3 - 24
  • 25. Monopolistic Competition, Oligopoly, & Public Welfare • Behavior is so varied that it is hard to come to a simple conclusion about welfare implications. • In many circumstances, the behavior of monopolistic competitors and oligopolists falls short of the social optimum. A3 - 25
  • 26. Monopolistic Competition, Oligopoly, & Public Welfare • Oligopolistic market can be perfectly contestable: ¤ If firms can enter and exit without losing the money they have invested • If so, then the performance of the firms is likely to be close to perfectly competitive • And thus, socially efficient A3 - 26
  • 27. Comparing the Four Market Forms • Perfect competition and pure monopoly are uncommon in reality. • Many monopolistically competitive firms exist. • Oligopoly firms account for the largest share of the economy’s output. A3 - 27
  • 28. Comparing the Four Market Forms • Profits are zero in long-run equilibrium under perfect competition and monopolistic competition because of free entry and exit. • Consequently, AC = AR = P in long-run equilibrium under these two market forms. A3 - 28
  • 29. Comparing the Four Market Forms • In equilibrium, MC = MR for the profit- maximizing firm under any market form. • In the equilibrium of the oligopoly firm, MC may be unequal to MR. A3 - 29
  • 30. Comparing the Four Market Forms • Perfectly competitive firm and industry theoretically ⇒ efficient allocation of resources. • Monopoly and monopolistic competition are likely ⇒ inefficient allocation of resources. • Under oligopoly, almost anything can happen, ⇒ impossible to generalize about its vices or virtues. A3 - 30
  • 31. TABLE 5: Attributes of the Four Market Forms Copyright© 2006 South-Western/Thomson Learning. All rights A3 - 31 reserved.
  • 32. Perfect Competition Markets By Mrs. N. Jayaprada 32 A3 - 32
  • 33. Introduction • The concept of competition is used in two ways in economics. ¤ Competition as a process is a rivalry among firms. ¤ Competition as the perfectly competitive market structure. ¤ A perfectly competitive market is one in which economic forces operate unimpeded 33 A3 - 33
  • 34. A Perfectly Competitive Market • A perfectly competitive market must meet the  The number of sellers and buyers is large. following requirements:  There are no barriers to entry and exit.  The firms’ products are identical or standardised.  Both buyers and sellers are price takers.  Each buyer and seller operates under conditions of certainty.  There is complete information.  Firms are profit maximizers.  Each firm takes its independent action.  Perfect mobility of factors of production A3 - 34
  • 35. The Competitive Industry and Firm typical firm can sell 1.The intersection of the market 3.The supply and the market demand all it wants at the curve… market price… Price Market Price Firm per unit per unit S 35 35 Demand Curve D Facing the Firm Units of output Units of output 2.determine the 4.so it faces a equilibrium market horizontal demand price curve 35 A3 - 35
  • 36. Goals and Constraints of the Competitive Firm • Perfectly competitive firm faces a cost constraint like any other firm • Cost of producing any given level of output depends on ¤ Firm’s production technology ¤ Prices it must pay for its inputs 36 A3 - 36
  • 37. Costs Relevant to a Firm P=MR= AR Output Total cost Marginal Average Total Profit Cost Total Cost Revenue TR-TC 0 40.00 - - 0 -40.00 35.00 1 68.00 28.00 68.00 35.00 -33.00 35.00 2 88.00 20.00 44.00 70.00 -18.00 35.00 3 104.00 16.00 34.67 105.00 1.00 35.00 4 118.00 14.00 29.50 140.00 22.00 35.00 5 130.00 12.00 26.00 175.00 45.00 35.00 6 147.00 17.00 24.50 210.00 63.00 35.00 7 169.00 22.00 24.14 245.00 76.00 35.00 8 199.00 30.00 24.88 280.00 81.00 35.00 9 239.00 40.00 26.56 315.00 76.00 35.00 10 293.00 54.00 29.30 350.00 57.00 A3 - 37
  • 38. Profit Determination Using Total Cost and Revenue Curves TC TR 385 Loss 350 Total cost, revenue 315 Maximum profit =81 Profit 280 245 210 130 175 140 105 Profit =45 70 35 Loss 0 1 2 3 4 5 6 7 8 9 Quantity A3 - 38
  • 39. Marginal Cost, Marginal Revenue, and Price MC Costs Price = MR Quantity Marginal Produced Cost 35.00 0 60 28.00 35.00 1 50 20.00 35.00 2 16.00 35.00 3 40 A C 14.00 P = AR = MR 35.00 4 B 12.00 30 A 35.00 5 17.00 35.00 6 22.00 20 35.00 7 30.00 35.00 8 10 40.00 35.00 9 54.00 0 35.00 10 68.00 1 2 3 4 5 6 7 8 9 10 Quantity A3 - 39
  • 40. Short run Equilibrium • Depending upon the positions of the short run cost curves, in short run, individual firm can make • Super normal profits • Normal profits • Losses 40 A3 - 40
  • 41. Determining Profits Graphically Price MC Price MC Price MC 65 65 65 60 60 60 55 55 55 50 50 50 ATC 45 45 ATC 45 40 D A P = MR=AR40 40 Loss P=MR=AR 35 35 35 30 Profit 30 P = MR=AR 30 B ATC 25 C 25 25 20 E 20 20 15 15 15 10 10 10 5 5 5 0 1 2 3 4 5 6 7 8 910 12 0 1 2 3 4 5 6 7 8 910 12 0 1 2 3 4 5 6 7 8 910 12 Quantity Quantity Quantity (a) Super Profit case (b) Normal profit case (c) Loss case A3 - 41
  • 42. Determining Profit and Loss From a Graph • Find output where MC = MR. ¤ The intersection of MC = MR (P) determines the quantity the firm will produce if it wishes to maximize profits.  Find profit per unit where MC = MR . Drop a line down from where MC equals MR, and then to the ATC curve. This is the profit per unit. Extend a line back to the vertical axis to identify total profit. A3 - 42
  • 43. Determining Profit and Loss From a Graph • The firm makes a super profit when the ATC curve is below the MR curve. • The firm makes a normal profit when the ATC curve is equal to the MR curve. • The firm incurs a loss when the ATC curve is above the MR curve. A3 - 43
  • 44. Special case: Exit / Shutdown • The shutdown point Pointpoint at which the is the firm will be better off it shuts down than it will if it stays in business. • If total revenue is more than total variable cost, the firm’s best strategy is to temporarily produce at a loss. • It is taking less of a loss than it would by shutting down. Condition I – Price < AVC – Shut down Condition II – Price >= AVC – Continue A3 - 44
  • 45. The Shutdown Decision MC Price 60 50 ATC 40 Loss 30 P = MR=AR AVC 20 A 10 0 2 6 4 8 Quantity A3 - 45
  • 46. Long-Run Competitive Equilibrium • Profits and losses are inconsistent with long-run equilibrium. ¤ Profits create incentives for new firms to enter, output will increase, and the price will fall until zero profits are made. ¤ The existence of losses will cause firms to leave the industry. ¤ In the long-run equilibrium of a competitive industry, all firms make normal profits. A3 - 46
  • 47. Long-Run Competitive Equilibrium MC Price 60 P=MR=AR=SAC=SMC=LAC 50 SRATC LRATC 40 30 P = MR=AR 20 10 0 2 4 6 8 Quantity A3 - 47
  • 48. Price Determination in a Perfectly Competitive Industry • In the short run, the price does more of the adjusting. • In the long run, more of the adjustment is done by quantity. A3 - 48
  • 49. Price Determination in a Perfectly Competitive Industry Price Determination in Market Period (very short run) s • Supply of the D’ D commodity is fixed as Price of Good P’ E’ inputs are fixed in D” P E supply. X P” E” D’ • Demand changes Price D and Equilibrium points D” also change accordingly. Quantity of Good X A3 - 49
  • 50. Price Determination in a Perfectly Competitive Industry Price Determination in short run • Supply of the D’ s commodity changes as Price of Good D variable factors can be P’ E’ changed but scale of X D” plant is not possible. P E D’ P” E” • Demand changes Price D s D” and Equilibrium points also change Quantity of Good X accordingly. A3 - 50
  • 51. Price Determination in a Perfectly Competitive Industry Price Determination in Long Run • Supply of the D commodity fully LP Price of Good D’ S adjusted to meet the P’ E’ changes in the industry X P E as scale of plant is E” possible. D D’ • Supply changes Price and Equilibrium points Quantity of Good X also change accordingly. A3 - 51