The theory of the firm
The theory of the firm
The theory of the firm
products.
Where do the firms sell their products ?
products ?
Do they earn profit or loss ?
product?
CONCEPT OF MARKET
Market is a place where buyers and sellers
meet in order to exchange goods and
services.
In economics market refers to an
Tim
• Very short, short & long period
e
Plac
• Local , national & int.national
e
Monopolistic
Oligopoly
Duopoly
Perfect competition
A form of market in which there are large number
of buyers and sellers buy and sell homogeneous
products at a single price.
Features
1.Large no. Of sellers and buyers
2. Homogeneous product
3. Single price
4. Freedom of entry and exit
5. Perfect market information
6. Price taker (Each firm)
7. No transport cost
8. Perfectly elastic demand curve
Revenue
The money income received by a firm or producer
from the sale of its output.
Total revenue
The total amount received by the firm (seller)from
the sale of a given units of the commodity.
TR = p X q
e.g TR = 100 x 6
TR = 600
Average revenue
Revenue from the sale of per unit of a commodity.
AR = TR /q 600/6 AR = 100
Marginal revenue
The additional revenue received from the
sale of an additional unit of the product.
MR = TRn – TR n- 1
e.g . MR = TR6 – TR6-1
MR = TR6 – TR 5
MR = 600 – 500
MR = 100
Average Revenue
Each firm in a perfectly competitive market
is a price taker. No single firm can
influence the market price.
P = AR = MR
Average revenue or Price line
in perfect competition market
Outpu
t
Y
Price
Price
P Line P = DD = AR =
MR
O Output X
In the above diagram on the OX axis we
measure output and on the OY axis we
measure market price / AR.
Price
Margin
al
Cost A B
P
O q1 q2 q3 q0 q4
Output
The figure is used to demonstrate that
when the market price is p, the output level
SAC
SAVC
P1 AR= MR= P
P2
0 Q1 Output
The figure shows the output levels chosen
by a profit-maximising firm in the short run
for two values of the market price: p1 and
p2. When the market price is p1, the output
level of the firm is q1; when the market
price is p2, the firm produces zero output.
Case 2 : P < AVC
Suppose the market price is p2, which is
less than the minimum AVC.
If a profit-maximising firm produces a
SAC
SAVC
AR= MR= P
P2
0
Output
Combining cases 1 and 2, we reach an
important conclusion. A firm’s short run
supply curve is the rising part of the SMC
curve from and above the minimum AVC
together with zero output for all prices
strictly less than the minimum AVC.
Long run supply curve of a Firm
Case 1 : P ≥ LRAC
We first determine the firm’s profit-
maximising output level when the market
price is greater
than or equal to the minimum LRAC.
Suppose the market price is p1, which
exceeds the minimum LRAC. Upon equating
p1 with LRMC on the rising part of the LRMC
curve, we obtain output level q1.
The LRAC at q1 does not exceed the market
price, p1. Thus, all three conditions are
satisfied at q1.
LRA
C
P1
P2
0
q1 Output
Profit maximisation in the Long Run for
Different Market Price Values. The figure
shows the output levels chosen by a profit
maximising firm in the long run for two
values of the market price: p1 and p2.
LRA
C
AR= MR= P
P2
0
Output
The Long Run Supply Curve of a Firm,
which is based on its long run marginal
cost curve (LRMC) and long run average
cost curve (LRAC), is represented by the
bold line.
Combining cases 1 and 2, we reach an
important conclusion. A firm’s long run
supply curve is the rising part of the LRMC
curve from and above the minimum LRAC
together with zero output for all prices less
than the minimum LRAC.
Supply curve in perfect
competition market
Y
S
P
3
P
2
P1
0 Q Q2 Q3 X
1
Shut down point
S = f (p)
5 12
10 14 20
15 16
20 18
15
25 20
10
S
5
0 Quantity 12 14 16 18 20
supply
Market supply
10 10 10 0 10 10
15 20 15 10 15 30
20 30 20 40 20 70
Firm A supply + Firm B
supply
The Market Supply Curve Panel. (a) shows
the supply curve of firm A. Panel (b) shows
the supply curve of firm B. Panel (c) shows
the market supply curve, which is obtained
by taking a horizontal summation of the
supply curves of the two firms.
Price elasticity of supply
A measure of the responsiveness of the
supply for a good to changes in its price.
S Excess D
demand
0 Q1 Q2 Q3 X
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