1. Chapter 5&6 Main Lecture on Revenue and Perfect Competition Chapter 5&6 Main Lecture on Revenue and Perfect Competition

2. 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

3. 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.

4. 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 horizontal. That means they believe: They can sell as much as they want at the going price. – –average revenue (AR) – –marginal revenue (MR)

5. 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

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

7. REVENUE Defining total, average and marginal revenue Revenue curves when firms are price takers (horizontal demand curve) – –average revenue (AR) – –marginal revenue (MR) – –total revenue (TR) Defining total, average and marginal revenue Revenue curves when firms are price takers (horizontal demand curve) – –average revenue (AR) – –marginal revenue (MR) – –total revenue (TR)

8. Total revenue for a price-taking firm TR (£) Quantity (units) 0 200 400 600 800 1000 1200 Price 55555555555555

9. TR (£) Quantity (units) 0 200 400 600 800 1000 1200 Price 55555555555555 TR (£) 0 1000 2000 3000 4000 5000 6000 Total revenue for a price-taking firm

10. TR (£) Quantity (units) 0 200 400 600 800 1000 1200 Price 55555555555555 TR (£) 0 1000 2000 3000 4000 5000 6000 Total revenue for a price-taking firm TR

11. TR (£) Quantity Total revenue for a price-taking firm TR

12. TR (£) Quantity (units) 0 200 400 600 800 1000 1200 Price = AR = MR (£) 55555555555555 TR (£) 0 1000 2000 3000 4000 5000 6000 Total revenue for a price-taking firm AR= TR/Q

13. TR (£) Quantity (units) 0 200 400 600 800 1000 1200 Price = AR = MR (£) 55555555555555 TR (£) 0 1000 2000 3000 4000 5000 6000 Total revenue for a price-taking firm AR= TR/Q 55555555555555

14. TR (£) Quantity (units) 0 200 400 600 800 1000 1200 Price = AR = MR (£) 55555555555555 TR (£) 0 1000 2000 3000 4000 5000 6000 Total revenue for a price-taking firm AR= TR/Q 55555555555555 MR

15. TR (£) Quantity (units) 0 200 400 600 800 1000 1200 Price = AR = MR (£) 55555555555555 TR (£) 0 1000 2000 3000 4000 5000 6000 Total revenue for a price-taking firm AR= TR/Q 55555555555555 MR 55555555555555 £5

16. Mathematics of Revenue: Average Revenue Total Revenue Marginal Revenue When P is constant

17. When is a firm a price taker? PERFECT COMPETITIONPERFECT COMPETITION Assumptions – –firms are price takers – treat P as constant – –freedom of entry – –identical products – –perfect knowledge PERFECT COMPETITIONPERFECT COMPETITION Assumptions – –firms are price takers – treat P as constant – –freedom of entry – –identical products – –perfect knowledge

18. VERY Short-run equilibrium of industry and firm under perfect competition OO S D (a) Industry P£ Q (millions)

19. VERY Short-run equilibrium of industry and firm under perfect competition OO S D (a) Industry P£ PePe Q (millions)

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

21. VERY 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 q (thousands)

22. Very 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) At what level of output should the firm Produce?

23. OO S D (a) Industry P£ Q (millions) PePe (b) Firm AR D = AR = MR MC qeqe AC q (thousands) Produce where MR = MC RULE ALWAYS

24. At Q e how much does profit does the firm make? OO S D (a) Industry P£ Q (millions) PePe (b) Firm AR D = AR = MR MC qeqe AC q (thousands)

25. OO S D (a) Industry P£ Q (millions) PePe (b) Firm AR D = AR = MR MC qeqe AC q (thousands) At Q e how much does profit does the firm make?

26. OO S D (a) Industry P£ Q (millions) PePe (b) Firm AR D = AR = MR MC QeQe AC Q (thousands) Area = (AR-AC)*q e At Q e how much does profit does the firm make?

27. 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 e =(AR – AC)*q e = Supernormal profitSupernormal profit

28. OO S D (a) Industry P£ Q (millions) PePe (b) Firm AR D = AR = MR MC qeqe AC q (thousands) Supernormal Profit

29. PERFECT COMPETITION – –Produce where MR = MC – –Under perfect Competition P = MR – –So MR= P = MC – –possible supernormal profits = (AR-AC)*q – –Produce where MR = MC – –Under perfect Competition P = MR – –So MR= P = MC – –possible supernormal profits = (AR-AC)*q

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

31. So supernormal profits attract more firms to the industry. OO S D (a) Industry P £ Q (millions) P (b) Firm AR D = AR = MR MC qeqe AC q (thousands) Before S = Q e = n* q e now S = Q 1 = (n+a) * q e

32. So Supply curve moves out! OO S D (a) Industry P £ Q (millions) P (b) Firm AR D = AR = MR MC Q AC Q (thousands) S1S1 QeQe Q1Q1 Before S = Q e = n* q e now S = Q 1 = (n+a) * q e

33. Price falls OO S D (a) Industry P £ Q (millions) PePe (b) Firm AR D = AR = MR MC QeQe AC Q (thousands) S1S1

34. OO S D (a) Industry P £ Q (millions) PePe (b) Firm AR D = AR = MR MC AC Q (thousands) S1S1

35. .. 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

36. 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

37. 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

38. Suppose now demand falls. OO D1D1 (a) Industry P £ Q (millions) P0P0 (b) Firm MC QeQe AC Q (thousands) S1S1 P1P1 PePe D0D0 What happens to supply now?

39. Suppose now demand falls. OO D1D1 (a) Industry P £ Q (millions) P0P0 (b) Firm MC QeQe AC Q (thousands) S1S1 P1P1 PePe D0D0 Our same MR = MC rule applies, but there is one more consideration

40. OO D1D1 P £ P0P0 MC Q1Q1 AC S1S1 P1P1 PePe D0D0 Our same MR = MC rule applies, but there is one more consideration We need to check where the AVC curve lies. Why? AVC In this case P > AVC so will continue to produce. By doing so, cover AVC and make some contribution to covering Fixed Costs Q0Q0

41. OO D1D1 P £ P0P0 MC Q1Q1 AC S1S1 P1P1 PePe D0D0 Our same MR = MC rule applies, but there is one more consideration We need to check where the AVC curve lies. Why? AVC But overall making a (supernormal) loss = FC – (P-AVC) Q0Q0

42. OO D1D1 P £ P0P0 MC QeQe AC S1S1 P1P1 PePe D0D0 What if P is below AVC? AVC In this case we can’t cover variable costs, so better to close down and only lose FC

43. Deriving the short-run supply curve OO (a) Industry P£ P1P1 Q (millions) (b) Firm D 1 = MR 1 Q (thousands) MC Q1Q1 a D1D1 S

44. OO (a) Industry P£ P1P1 Q (millions) D1D1 (b) Firm D 1 = MR 1 MC Q2Q2 a P2P2 D 2 = MR 2 b S D2D2 Q (thousands) Deriving the short-run supply curve

45. OO (a) Industry P£ P1P1 Q (millions) S D1D1 (b) Firm D 1 = MR 1 MC Q3Q3 a P2P2 D 2 = MR 2 D2D2 b P3P3 D 3 = MR 3 D3D3 c Q (thousands) Deriving the short-run supply curve AVC

46. 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 AVC

47. PERFECT COMPETITION Short-run supply curve of industry Long-run equilibrium of the firm – –all supernormal profits competed away – –long-run industry supply curve Short-run supply curve of industry Long-run equilibrium of the firm – –all supernormal profits competed away – –long-run industry supply curve

48. OO D (a) Industry P £ Q (millions) (b) Firm D = AR = MR MC QeQe AC Q (thousands) S PePe PePe D1D1 What happened to Supply here in the Long Run S1S1 LRS

49. P Q O Various long-run industry supply curves under perfect competition S1S1 D1D1 a (a) Constant industry costs

50. P Q O Various long-run industry supply curves under perfect competition S1S1 D1D1 D2D2 a b (a) Constant industry costs

51. P Q O Various long-run industry supply curves under perfect competition S1S1 D1D1 S2S2 D2D2 a b c (a) Constant industry costs

52. P Q O Various long-run industry supply curves under perfect competition Long-run S S1S1 D1D1 S2S2 D2D2 a b c (a) Constant industry costs

53. OO D (a) Industry P £ Q (millions) (b) Firm D = AR = MR MC QeQe AC q (thousands) S PePe PePe D1D1 What if there are external economies to scale in the Long Run? 1. Demand moves out

54. OO D (a) Industry P £ Q (millions) (b) Firm D = AR = MR MC Q0Q0 AC q (thousands) S PePe PePe D1D1 What if there are external economies to scale in the Long Run? 2. Firm moves up MC curve. S 1 = nq 1 q0q0 q1q1

55. OO D (a) Industry P £ Q (millions) (b) Firm D = AR = MR MC Q0Q0 AC q (thousands) S PePe PePe D1D1 What if there are external economies to scale in the Long Run? 3. Supernormal Profits – So firms join the industry q0q0 q1q1

56. OO D (a) Industry P £ Q (millions) (b) Firm D = AR = MR MC Q0Q0 AC q (thousands) S PePe PePe D1D1 4. But with External Economies of scale as S curve moves out, AC curve starts to move down q0q0 S1S1

57. OO D (a) Industry P £ Q (millions) (b) Firm D = AR = MR MC Q0Q0 AC q (thousands) S PePe PePe D1D1 4. So with External Economies of scale, Find new equilibrium with lower AC, higher supply and lower price q0q0 S1S1

58. OO D (a) Industry P £ Q (millions) (b) Firm D = AR = MR MC QeQe AC Q (thousands) S PePe PePe D1D1 So if there are external economies to scale in the Long Run? S1S1 LRS

59. OO D (a) Industry P £ Q (millions) (b) Firm D = AR = MR MC QeQe AC Q (thousands) S PePe PePe D1D1 So if there are external economies to scale in the Long Run? S1S1 LRS

60. P Q O S1S1 D1D1 D2D2 a b Various long-run industry supply curves under perfect competition (c) Decreasing industry costs: external economies of scale

61. P Q O S1S1 D1D1 S2S2 D2D2 a b c Various long-run industry supply curves under perfect competition (c) Decreasing industry costs: external economies of scale

62. P Q O Long-run S S1S1 D1D1 S2S2 D2D2 a b c Various long-run industry supply curves under perfect competition (c) Decreasing industry costs: external economies of scale

63. OO D (a) Industry P £ Q (millions) (b) Firm D = AR = MR MC QeQe AC q (thousands) S PePe PePe D1D1 What if there are external Diseconomies to scale in the Long Run?

64. External Diseconomies to Scale I want you to analyse the various effects on the market and the firm when this occurs. Classes on week 6: Hand in Short Essay Structure 1. Motivate: Why might this occur? 2. Anaslyse (both firm and market) 3. Evaluate How many words?

65. Inframarginal Producers In some industries such as agriculture, new entrants may have higher costs than existing producers (worse land etc.)In some industries such as agriculture, new entrants may have higher costs than existing producers (worse land etc.) Classes on week 7: Hand in Short Essay Structure 1. Motivate: Why might this occur in other industries 2. Anaslyse (both firm and market) 3. Evaluate instance and implications How many words?

66. Essay Writing Length: Approximately 800-1000 words, or about 3 sides of A4 paper, including diagrams (depends on how big your diagrams are).Length: Approximately 800-1000 words, or about 3 sides of A4 paper, including diagrams (depends on how big your diagrams are). See p 32 -35 in Economics Handbook for further advice on essay writing.See p 32 -35 in Economics Handbook for further advice on essay writing.

67. PERFECT COMPETITION Short-run supply curve of industry Long-run equilibrium of the firm – –all supernormal profits competed away – –long-run industry supply curve Incompatibility of INTERNAL economies of scale with perfect competition Short-run supply curve of industry Long-run equilibrium of the firm – –all supernormal profits competed away – –long-run industry supply curve Incompatibility of INTERNAL economies of scale with perfect competition

68. PERFECT COMPETITION Advantages of perfect competition – –P = MC – –production at minimum AC – –only normal profits in long run – –responsive to consumer wishes: consumer sovereignty – –competition  efficiency – –no point in advertising Advantages of perfect competition – –P = MC – –production at minimum AC – –only normal profits in long run – –responsive to consumer wishes: consumer sovereignty – –competition  efficiency – –no point in advertising

69. PERFECT COMPETITION (ALLEGED) Disadvantages of perfect competition – –insufficient profits for investment – –lack of product variety – –lack of competition over product design and specification Not really valid set of criticisms (ALLEGED) Disadvantages of perfect competition – –insufficient profits for investment – –lack of product variety – –lack of competition over product design and specification Not really valid set of criticisms

70. PERFECT COMPETITION Disadvantages of perfect competition – –There are none Except perhaps…. – –Disadvantage is that it may not be a valid version of reality – –Recall assumptions   firms are price takersOK   freedom of entry and exitiffy   identical productsFew examples   perfect knowledgeiffy Disadvantages of perfect competition – –There are none Except perhaps…. – –Disadvantage is that it may not be a valid version of reality – –Recall assumptions   firms are price takersOK   freedom of entry and exitiffy   identical productsFew examples   perfect knowledgeiffy