Download PRINCIPLE OF ECONOMICS

Microeconomics
© Oxford University Press Malaysia, 2008
All Rights Reserved
8– 1
CHAPTER
8
Theory of Firm
Microeconomics
© Oxford University Press Malaysia, 2008
All Rights Reserved
8– 2
CONCEPT OF REVENUE
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)
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)
AR = P x Q
=
Total Revenue (TR)
Quantity (Q)
= PRICE
Q
Microeconomics
© Oxford University Press Malaysia, 2008
All Rights Reserved
8– 3
CONCEPT OF REVENUE
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
(1)
Quantity
(2)
Price
(3)
Total Revenue
(1)X(2)
(4)
Average Revenue
(3) / (1)
(4)
Marginal Revenue
(3) / (1)
10
50
500
50
50
20
45
900
45
40
30
40
1200
40
30
40
35
1400
35
20
50
30
1500
30
10
60
25
1500
25
0
70
20
1400
20
-10
Microeconomics
© Oxford University Press Malaysia, 2008
All Rights Reserved
8– 4
CONCEPT OF REVENUE
Case I: Imperfect Market
Quantity
Price
Total Revenue
(TR)
Marginal Revenue
(MR)
10
10
100
10
10
20
9
180
9
8
30
8
240
8
6
40
7
280
7
4
50
6
300
6
2
15
AR, MR
Average Revenue
(AR)
Price
10
Price
AR
5
MR
0
10
20
30
40
Microeconomics
© Oxford University Press Malaysia, 2008
50
Quantity
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.
All Rights Reserved
8– 5
CONCEPT OF REVENUE (CON’T)
Case II: Perfect Market
Quantity
Price
Total Revenue
(TR)
Marginal Revenue
(MR)
10
10
100
10
10
20
10
200
10
10
30
10
300
10
10
40
10
400
10
10
50
10
500
10
10
15
AR, MR
Average Revenue
(AR)
Price
10
AR
5
MR
0
10
20
30
40
Microeconomics
© Oxford University Press Malaysia, 2008
50
Quantity
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.
All Rights Reserved
8– 6
CONCEPT OF REVENUE BY
EQUATION
Given demand curve as: P = a – bQ
TR = P x Q
= (a – bQ) x Q
= aQ – bQ2
(b is the slope)
Derivation of MR from demand curve
MR = dTR/dQ
MR = a – 2bQ
(MR is ½ of the slope of DD)
Microeconomics
© Oxford University Press Malaysia, 2008
All Rights Reserved
8– 7
DIFFERENCES BETWEEN ECONOMIC
PROFIT AND ACCOUNTING PROFIT
Economic Profit
 Economic profit is defined
as the total revenue minus
the implicit and explicit
cost.
Accounting Profit
 Accounting profit is
defined as the firm’s total
revenue minus the explicit
cost.
 Considers explicit and
implicit cost.
 EC = TR – [Explicit Cost +
Implicit Cost]
Microeconomics
© Oxford University Press Malaysia,
2008
MICROECONOMICS
 Considers only explicit
cost
 AC = TR – Explicit Cost
All Rights Reserved
8– 88
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.
Microeconomics
© Oxford University Press Malaysia, 2008
All Rights Reserved
8– 9
OBJECTIVES OF A FIRM
The main goal or objective of a
firm is to maximize profit and to
minimize the cost.
Microeconomics
© Oxford University Press Malaysia, 2008
All Rights Reserved
8– 10
TOTAL REVENUE USING
THE TOTAL COST APPROACH
Case I: Perfect Market
(1)
Quantity
(Q)
(2)
Price
(P)
0
300
0
100
-100
1
300
300
500
-200
2
300
600
600
0
3
300
900
4
300
1200
5
300
1500
300
1800
6
(3)
Total Revenue
(TR)
(4)
Total Cost
(TC)
800
9500
1150
1400
(5)
Profit
(TR - TC)
100
250
350
400
7
300
2100
8
300
2400
2100
300
9
300
2700
2700
0
10
300
3000
3100
-100
Microeconomics
© Oxford University Press Malaysia, 2008
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.
400
All Rights Reserved
8– 11
TOTAL REVENUE USING
TOTAL COST APPROACH (CON’T)
Case I: Perfect Market
TR, TC
TC
Using Graph:
TR
TR curve is a straight line through
the origin.
The maximum profit is where the
vertical difference is the highest.
Highest
vertical
differences
Quantity
Microeconomics
© Oxford University Press Malaysia, 2008
All Rights Reserved
8– 12
TOTAL REVENUE USING
TOTAL COST APPROACH (CON’T)
Case II: Imperfect Market
(1)
Quantity
(Q)
(2)
Price
(P)
(3)
Total Revenue
(TR)
0
340
0
200
-200
1
340
340
400
-60
2
330
660
560
100
3
320
960
4
310
1240
5
300
1500
290
1740
6
(4)
Total Cost
(TC)
700
800
900
1040
(5)
Profit
(TR - TC)
260
440
600
700
7
280
1960
8
270
2160
1200
760
9
260
2340
1800
540
10
240
2400
2400
0
Microeconomics
© Oxford University Press Malaysia, 2008
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.
760
All Rights Reserved
8– 13
TOTAL REVENUE USING
TOTAL COST APPROACH (CON’T)
Case II: Imperfect Market
TR, TC
Using Graph :
TC
TR curve is increasing and after the
profit maximizing output, the curve
starts to decline.
TR
Maximum profit is where the
vertical difference between TR and
TC is the highest.
Highest
vertical
differences
Quantity
Microeconomics
© Oxford University Press Malaysia, 2008
All Rights Reserved
8– 14
MARGINAL REVENUE USING
MARGINAL COST APPROACH
Case I: Perfect Market
Quantity
(Q)
Price
(P)
Marginal
Revenue
(MR)
Marginal
Cost
(MC)
0
300
300
400
1
300
300
200
2
300
300
100
3
300
300
150
4
300
300
200
5
300
300
250
6
300
300
450
7
300
300
300
8
300
300
400
9
300
300
600
10
300
300
700
Microeconomics
© Oxford University Press Malaysia, 2008
Using Table:
Profit maximizing
output level is obtained
following the
MR = MC rule.
All Rights Reserved
8– 15
MARGINAL REVENUE USING
MARGINAL COST APPROACH (CON’T)
Case I: Perfect Market
MR, MC
MC
Using Graph:
MR curve is perfectly elastic or
horizontal to the price.
P*
The profit maximization rule,
MR = MC, where the MC curve
intersect with the
MR curve.
MR
Quantity
Q*
Microeconomics
© Oxford University Press Malaysia, 2008
All Rights Reserved
8– 16
MARGINAL REVENUE USING
MARGINAL COST APPROACH (CON’T)
Case II: Imperfect Market
Quantity
(Q)
Price
(P)
Marginal
Revenue
(MR)
Marginal
Cost
(MC)
0
340
1
340
340
200
2
330
320
160
3
320
300
150
4
310
280
200
5
300
260
250
6
290
240
450
7
280
220
300
8
270
200
400
9
260
180
600
10
240
60
700
Microeconomics
© Oxford University Press Malaysia, 2008
Using Table:
Profit maximizing
output level is obtained
following the
MR = MC rule.
All Rights Reserved
8– 17
MARGINAL REVENUE USING
MARGINAL COST APPROACH (CON’T)
Case II: Imperfect Market
MR, MC
MC
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.
P*
AR=P
MR
Quantity
Q*
Microeconomics
© Oxford University Press Malaysia, 2008
All Rights Reserved
8– 18
TYPES OF MARKET STRUCTURE
MONOPOLISTIC
COMPETITION
MONOPOLY
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.
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.
PERFECT COMPETITION
There 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.
Microeconomics
© Oxford University Press Malaysia, 2008
TYPES OF
MARKET
STRUCTURE
OLIGOPOLY
There 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.
All Rights Reserved
8– 19
TYPES OF MARKET STRUCTURE
(CON’T)
Market Structure
Characteristics
Number of firms
Perfect
competition
Very large number
Monopolistic
competition
Oligopoly
Monopoly
Large number
Few
One
Type of firms
Homogenous
Dfferentiated
Homogenous or
differentiated
Unique: no close
substitutes
Conditions to
Entry
Very easy
Easy
Significant
obstacles
Entry not
possible
Control over
Price taker
Price taker
Independent
Price maker
Promotion
strategy
No
Yes
Yes
Noor little
Demand curve
Horizontal
Downward slope
Kinked
Downward slope
price
Microeconomics
© Oxford University Press Malaysia, 2008
All Rights Reserved
8– 20