All Rights ReservedMicroeconomics © Oxford University Press Malaysia, – 1

All Rights ReservedMicroeconomics © Oxford University Press Malaysia, – 2 Theory of Firm 8 CHAPTER

All Rights ReservedMicroeconomics © Oxford University Press Malaysia, – 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

All Rights ReservedMicroeconomics © Oxford University Press Malaysia, – 4 CONCEPT OF REVENUE (1) Quantity (2) Price (3) Total Revenue (1)X(2) (4) Average Revenue (3) / (1) (4) Marginal Revenue  (3) /  (1) 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

All Rights ReservedMicroeconomics © Oxford University Press Malaysia, – 5 QuantityPriceTotal Revenue (TR) Average Revenue (AR) Marginal Revenue (MR) CONCEPT OF REVENUE Case 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 AR, MR Price AR MR

All Rights ReservedMicroeconomics © Oxford University Press Malaysia, – 6 QuantityPriceTotal Revenue (TR) Average Revenue (AR) Marginal Revenue (MR) 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 AR, MR Price AR MR

All Rights ReservedMicroeconomics © Oxford University Press Malaysia, – 7 Given demand curve as: P = a – bQ(b is the slope) TR=P x Q =(a – bQ) x Q =aQ – bQ 2 Derivation of MR from demand curve MR=dTR/dQ MR=a – 2bQ (MR is ½ of the slope of DD) CONCEPT OF REVENUE BY EQUATION

All Rights ReservedMicroeconomics © Oxford University Press Malaysia, – 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

All Rights ReservedMicroeconomics © Oxford University Press Malaysia, – 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.

All Rights ReservedMicroeconomics © Oxford University Press Malaysia, – 10 The main goal or objective of a firm is to maximize profit and to minimize the cost. OBJECTIVES OF A FIRM

All Rights ReservedMicroeconomics © Oxford University Press Malaysia, – 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)

All Rights ReservedMicroeconomics © Oxford University Press Malaysia, – 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) Case I: Perfect Market

All Rights ReservedMicroeconomics © Oxford University Press Malaysia, – 13 TOTAL REVENUE USING TOTAL COST APPROACH (CON’T) Case II: Imperfect Market (1) Quantity (Q) (2) Price (P) (3) Total Revenue (TR) (4) Total Cost (TC) (5) Profit (TR - TC) 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.

All Rights ReservedMicroeconomics © Oxford University Press Malaysia, – 14 TR, TC Quantity TC TR Highest vertical differences TOTAL REVENUE USING TOTAL COST APPROACH (CON’T) Case II: Imperfect Market 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.

All Rights ReservedMicroeconomics © Oxford University Press Malaysia, – 15 Case I: Perfect Market Using Table: Profit maximizing output level is obtained following the MR = MC rule. Quantity (Q) Price (P) Marginal Revenue (MR) Marginal Cost (MC) MARGINAL REVENUE USING MARGINAL COST APPROACH

All Rights ReservedMicroeconomics © Oxford University Press Malaysia, – 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. Case I: Perfect Market

All Rights ReservedMicroeconomics © Oxford University Press Malaysia, – 17 MARGINAL REVENUE USING MARGINAL COST APPROACH (CON’T) Case II: Imperfect Market Using Table: Profit maximizing output level is obtained following the MR = MC rule. Quantity (Q) Price (P) Marginal Revenue (MR) Marginal Cost (MC)

All Rights ReservedMicroeconomics © Oxford University Press Malaysia, – 18 MR, MC Quantity MC MR P* Q* AR=P MARGINAL REVENUE USING MARGINAL COST APPROACH (CON’T) Case II: Imperfect Market 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.

All Rights ReservedMicroeconomics © Oxford University Press Malaysia, – 19 TYPES OF MARKET STRUCTURE MONOPOLISTIC 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 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. 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. 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. TYPES OF MARKET STRUCTURE TYPES OF MARKET STRUCTURE

All Rights ReservedMicroeconomics © Oxford University Press Malaysia, – 20 TYPES OF MARKET STRUCTURE (CON’T) Characteristics Perfect competition Monopolistic competition Oligopoly Monopoly Market Structure Type of firmsHomogenousDfferentiatedHomogenous or Unique: no close differentiatedsubstitutes Conditions to Very easyEasySignificant Entry not Entryobstaclespossible Control overPrice takerPrice takerIndependentPrice maker price Promotion NoYesYesNoor little strategy Demand curveHorizontalDownward slopeKinkedDownward slope Number of firmsVery large numberLarge numberFewOne