Revenue We have looked at Production and then Cost so we have anaylsed our technical capabilities and the costs of producing output,We have looked at Production and then Cost so we have anaylsed our technical capabilities and the costs of producing output, on averageon average and at the margin (one more unit)and at the margin (one more unit) Now we have to examine what we get for an additional unitNow we have to examine what we get for an additional unit

REVENUE Thus we need to defining total, average and marginal revenue We start by examining revenue curves when firms are price takers By this we mean that firms are small relative to the total market and that they do not have much influence over the price charged. In such a market if they raise price, people will go elsewhere… … and if they reduce price (even if it were profitable) they would not be able to cope with the resultant demand. Thus we need to defining total, average and marginal revenue We start by examining revenue curves when firms are price takers By this we mean that firms are small relative to the total market and that they do not have much influence over the price charged. In such a market if they raise price, people will go elsewhere… … and if they reduce price (even if it were profitable) they would not be able to cope with the resultant demand.

Revenue That is, they perceive the price they can receive as constant.That is, they perceive the price they can receive as constant. So as far as they are concerned the demand curve isSo as far as they are concerned the demand curve is. That means they believe: They can sell as much as they want at the going price. – –average revenue (AR) – –marginal revenue (MR)

Deriving a firm’s AR and MR: price-taking firm O O Price (£) AR, MR (£) Q (millions)Q (hundreds) PePe S D (a) The market(b) The firm

TR (£) Quantity (units) Price TR (£) Total revenue for a price-taking firm TR

When is a firm a price taker? PERFECT COMPETITIONPERFECT COMPETITION Assumptions – –firms are price takers – –freedom of entry – –identical products – –perfect knowledge PERFECT COMPETITIONPERFECT COMPETITION Assumptions – –firms are price takers – –freedom of entry – –identical products – –perfect knowledge

Short-run equilibrium of industry and firm under perfect competition OO S D (a) Industry P£ Q (millions) PePe (b) Firm AR D = AR = MR MC QeQe AC Q (thousands)

Supernormal Profits What was included in total costs when we drew the TC and AC curves?What was included in total costs when we drew the TC and AC curves? We included the cost of capital, labour, and raw, materials and …………….We included the cost of capital, labour, and raw, materials and ……………. An appropriate return for the entrepreneur for his or her labour, capital invested and riskAn appropriate return for the entrepreneur for his or her labour, capital invested and risk So what does the yellow area represent?So what does the yellow area represent? (AR – AC)*Q =(AR – AC)*Q = Supernormal profitSupernormal profit

Short-run equilibrium of industry and firm under perfect competition OO S D (a) Industry P£ Q (millions) PePe (b) Firm AR D = AR = MR MC QeQe AC Q (thousands) Supernormal Profit

PERFECT COMPETITION – –Produce where MR = MC – –Under perfect Competition P = MR – –So MR= P = MC – –possible supernormal profits = (AR-AC)*Q – –What is this firm’s supply curve in the Short- Run? – –Produce where MR = MC – –Under perfect Competition P = MR – –So MR= P = MC – –possible supernormal profits = (AR-AC)*Q – –What is this firm’s supply curve in the Short- Run?

OO (a) Industry P£ P1P1 Q (millions) S D1D1 (b) Firm D 1 = MR 1 S a P2P2 D 2 = MR 2 D2D2 b P3P3 D 3 = MR 3 D3D3 c Q (thousands) Deriving the short-run supply curve

.. And a new LONG RUN equilibrium is established at P e,Q e OO S D (a) Industry P £ Q (millions) P (b) Firm AR D = AR = MR MC QeQe AC Q (thousands) S1S1 PePe

PERFECT COMPETITION Short-run supply curve of industry Long-run equilibrium of the firm – –all supernormal profits competed away – –Since AR=AC and – –(AR-AC)*Q=0 Short-run supply curve of industry Long-run equilibrium of the firm – –all supernormal profits competed away – –Since AR=AC and – –(AR-AC)*Q=0

So the LONG RUN Equilibrium under Perfect Competition requires that AR=P=MR=MC=AC OO D (a) Industry P £ Q (millions) (b) Firm D = AR = MR MC QeQe AC Q (thousands) S1S1 PePe PePe

..and quantity and price rise. OO D (a) Industry P £ Q (millions) P (b) Firm D = AR = MR MC QeQe AC Q (thousands) S1S1 PePe PePe D1D1 In particular, each existing firm supplies more, up along its SR Supply curve, the MC curve.

OO D (a) Industry P £ Q (millions) (b) Firm D = AR = MR MC QeQe AC Q (thousands) S PePe PePe D1D1 When will firms stop entering? When all supernormal profits have gone. That is, when the price returns to P e..and firm output is back at Q e S1S1