Transcript Handout for Lecture on Ch 5.3 & 6

Revenue
• We have looked at Production and then
Cost so we have anaylsed our technical
capabilities and the costs of producing
output,
• on average
• and at the margin (one more unit)
• Now 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.
Revenue
• That is, they perceive the price they can
receive as constant.
• So 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)
S
AR, MR (£)
Price (£)
Deriving a firm’s AR and MR: price-taking firm
Pe
D
O
Q (millions)
(a) The market
O
Q (hundreds)
(b) The firm
Total revenue for a price-taking firm
Quantity
(units)
6000
0
200
400
600
800
1000
1200
TR (£)
5000
4000
3000
Price
5
5
5
5
5
5
5
TR
TR
(£)
0
1000
2000
3000
4000
5000
6000
2000
1000
0
0
200
400
600
Quantity
800
1000
1200
When is a firm a price taker?
• PERFECT COMPETITION
• Assumptions
– firms are price takers
– freedom of entry
– identical products
– perfect knowledge
Short-run equilibrium of industry and firm under
perfect competition
P
£
MC
S
Pe
D = AR
= MR
AR
AC
D
O
O
Q (millions)
(a) Industry
AC
Qe
Q (thousands)
(b) Firm
Supernormal Profits
• 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 …………….
• An appropriate return for the entrepreneur
for his or her labour, capital invested and
risk
• So what does the yellow area represent?
• (AR – AC)*Q =
• Supernormal profit
Short-run equilibrium of industry and firm under
perfect competition
Supernormal
Profit
P
£
MC
S
Pe
D = AR
= MR
AR
AC
D
O
O
Q (millions)
(a) Industry
AC
Qe
Q (thousands)
(b) Firm
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 ShortRun?
Deriving the short-run supply curve
S
P
£
S
a
P1
b
P2
c
P3
D1 = MR1
D2 = MR2
D3 = MR3
D1
D3
O
D2
O
Q (millions)
(a) Industry
Q (thousands)
(b) Firm
.. And a new LONG RUN equilibrium is established at
Pe,Qe
P
S
P
S1
MC
£
AR
AC
Pe
D = AR
= MR
D
O
O
Q (millions)
(a) Industry
AC
Qe
Q (thousands)
(b) Firm
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
So the LONG RUN Equilibrium under Perfect
Competition requires that AR=P=MR=MC=AC
P
S1
MC
£
D = AR
= MR
Pe
Pe
D
O
O
Q (millions)
(a) Industry
AC
Qe
Q (thousands)
(b) Firm
..and quantity and price rise.
In particular, each existing firm supplies more,
up along its SR Supply curve, the MC curve.
P
MC
S1
£
AC
P
D = AR
= MR
Pe
Pe
D
O
D1
O
Q (millions)
(a) Industry
Qe
Q (thousands)
(b) Firm
P
When will firms stop entering?
When all supernormal profits have gone.
That is, when the price returns to Pe
..and firm output is back at Qe
MC
S S £
1
D = AR
= MR
Pe
Pe
D
O
D1
O
Q (millions)
(a) Industry
AC
Qe
Q (thousands)
(b) Firm