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

2. All Rights ReservedMicroeconomics © Oxford University Press Malaysia, 2008 8– 2 Theory of Firm 8 CHAPTER

3. All Rights ReservedMicroeconomics © Oxford University Press Malaysia, 2008 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

4. All Rights ReservedMicroeconomics © Oxford University Press Malaysia, 2008 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 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

5. All Rights ReservedMicroeconomics © Oxford University Press Malaysia, 2008 8– 5 QuantityPriceTotal 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 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 5 10 15 01020304050 AR, MR Price AR MR

6. All Rights ReservedMicroeconomics © Oxford University Press Malaysia, 2008 8– 6 QuantityPriceTotal Revenue (TR) Average Revenue (AR) Marginal Revenue (MR) 10 20 30 40 50 10 100 200 300 400 500 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 01020304050 AR, MR Price AR MR

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

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

9. All Rights ReservedMicroeconomics © Oxford University Press Malaysia, 2008 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.

10. All Rights ReservedMicroeconomics © Oxford University Press Malaysia, 2008 8– 10 The main goal or objective of a firm is to maximize profit and to minimize the cost. OBJECTIVES OF A FIRM

11. All Rights ReservedMicroeconomics © Oxford University Press Malaysia, 2008 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 0 300 600 900 1200 1500 1800 2100 2400 2700 3000 100 500 600 800 9500 1150 1400 2100 2700 3100 -100 -200 0 100 250 350 400 300 0 -100

12. All Rights ReservedMicroeconomics © Oxford University Press Malaysia, 2008 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) Case I: Perfect Market

13. All Rights ReservedMicroeconomics © Oxford University Press Malaysia, 2008 8– 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) 0 1 2 3 4 5 6 7 8 9 10 340 330 320 310 300 290 280 270 260 240 0 340 660 960 1240 1500 1740 1960 2160 2340 2400 200 400 560 700 800 900 1040 1200 1800 2400 -200 -60 100 260 440 600 700 760 540 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.

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

15. All Rights ReservedMicroeconomics © Oxford University Press Malaysia, 2008 8– 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) 0 1 2 3 4 5 6 7 8 9 10 300 400 200 100 150 200 250 450 300 400 600 700 MARGINAL REVENUE USING MARGINAL COST APPROACH

16. All Rights ReservedMicroeconomics © Oxford University Press Malaysia, 2008 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. Case I: Perfect Market

17. All Rights ReservedMicroeconomics © Oxford University Press Malaysia, 2008 8– 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) 0 1 2 3 4 5 6 7 8 9 10 340 330 320 310 300 290 280 270 260 240 340 320 300 280 260 240 220 200 180 60 200 160 150 200 250 450 300 400 600 700

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

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

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