The theory of the firm

Download as pptx, pdf, or txt
Download as pptx, pdf, or txt
You are on page 1of 54

CHAPTER -4

THE THEORY OF THE FIRM AND


PERFECT COMPETITION
INTRODUCTION
 A firm produce products by using inputs such
as land , labour , capital and raw materials
etc, that means incur cost of production.
 A business firm gets its revenue by selling its

products.
 Where do the firms sell their products ?

 At what price do the producers sell their

products ?
 Do they earn profit or loss ?

 What forces determine the price of a

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

arrangement where buyers and sellers


come in contact with each other directly or
indirectly to buy or sell the goods.
 Market does not require definite place i.e.

face to face contact of buyers and sellers is


not necessary.
Four essentials of market
 Commodity
 Presence of buyers and sellers
 Market price
 A place or means of communication
Firm and industry
 Firm is a unit or part of industry carrying a
type of business in an industry.
 A firm operates inside an industry.

E.g :Automobile industry - TATA motors,


honda , hyundai, maruti suzuki, etc

 Industryis a group of firms carrying a type


of business in an economy.
Difference b/w firm and
industry
Firm Industry
A business established inside an A group of firms doing the same
industry business
Existence of only one firm Many firms in one industry
possible
A sub-sector of a type of business A sub- sector of an economy
No separate rules and Same rules and regulations for
regulations for a firm an industry
Market structure
the nature and degree of competition in the
market for goods and services.
or
The selling environment in which a firm
produces
and sells its products.
Elements of mkt strucuture
 No. of firms i.e. degree of competition
 Nature of the products – homogeneous
 Firms freedom to entre & exit
Classification of markets

Tim
• Very short, short & long period
e

Plac
• Local , national & int.national
e

• Perfect & imperfect


com
peti competition
tion
Imperfect competition
Monopoly

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.

 Since all the units are the same price , each


unit would have the same average revenue,
so Price line equal to average revenue.

 P = AR = MR
Average revenue or Price line
in perfect competition market

Boxes Price TR = P X Q AR = MR = TRn – TR n-1


sold (P) TR/Q
(Q)
0 10 0 0 0
1 10 10 10 10
2 10 20 10 10
3 10 30 10 10
4 10 40 10 10
5 10 50 10 10
6 10 60 10 10
 Lets assume that market for candles be
perfectly competitive and the market price
of a box of candles be Rs.10.

 When no box is sold, TR is equal to zero; if


one box of candles sold, TR is equal to 10x
1 = Rs.10.

 If two boxes of candles sold, TR is equal to


10 x 2 = 20 and so on.
Total Revenue curve. The
Revenu

total revenue curve of a


TR firm shows the relationship
e

between the total


revenue that the firm earns
and the output level of the
firm.

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.

 Since the market price is fixed at P, We


obtain a horizontal straight line that cuts
the vertical axis at a height equal to P. The
horizontal line is called price line. It is also
called the average revenue curve under
perfect competition.
 The price line also shows the demand curve
facing a firm. The DD curve is perfectly
elastic. This means that a firm can sell as
many units of the good as it wants to sell at
price P.
Profit Maximisation
 A firm produces and sells a certain amount
of a good.
 The firm’s profit, denoted by ∏, is defined

to be the difference between its total


revenue (TR) and its total cost of
production (TC ).
 In other words ∏ = TR – TC
 A firm wishes to maximise its profit. The
firm would like to identify the quantity q0
at which its profits are maximum.
 By definition, then, at any quantity other

than q0 , the firm’s profits are less than at


q0.
 For profits to be maximum, three conditions must
hold at q0:

1.The price, p, must equal MC (P= MC)

2. Marginal cost must be non-decreasing at q0

3. For the firm to continue to produce, in the short


run, price must be greater than the average
variable cost (p > AVC); in the long run, price must
be
greater than the average cost (p > AC).
Conditions 1 and 2 for profit
maximisation
MC

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

of a profit maximising firm cannot be q1


 (marginal cost curve,MC, is downward

sloping), q2 and q3 (market price exceeds


marginal cost), or q4 (marginal cost
exceeds market price).
 Therefore q0 is the profit maximising level

of output of the firm.


Supply
the quantity of a product which sellers offer
for sale at a particular level of price and
particular period of time.
Supply curve of a firm (level of output)
Depends on price , cost of production &
period of time
Firms supply curve in short run & long run.
Short run supply curve
Case 1 : P ≥ AVC
 The firm’s profit-maximising output level when
the market price greater than or equal to the
minimum of AVC.

 Suppose the market price is P1, which exceeds


the minimum AVC. We obtain supply curve by
equating P1 with SMC on the rising part of the
SMC curve, this leads to the output level q1.
 At q1 AVC does not exceed the market price,P1.
 Thus the conditions P=SMC, SMC is not
decreasing and P ≥ AVC are fulfilled.
Price SMC
Cost

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

positive output in the short run, then the


market price, p2, must be greater than or
equal to the AVC at that output level.
 But notice from Figure that for all positive

output levels, AVC strictly exceeds p2.


 So, if the market price is p2, the firm

produces zero output.


Price SMC
Cost

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.

 Hence, when the market price is p1, the firm’s


supplies in the long run become an output
equal to q1.
LRMC
Price
Cost

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.

 When the market is p1, the output level of


the firm is q1; when the market price is p2,
the firm produces zero output.
Case 2 : Price less than the
minimum LRAC
 Suppose the market price is p2, which is
less than the minimum LRAC. We have
argued that if a profit-maximising firm
produces a positive output in the long run,
the market price, p2, must be greater than
or equal to the LRAC at that output level.
 It cannot be the case that the firm supplies

a positive output. So, when the market


price is p2, the firm produces zero output.
Price LRMC
Cost

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

• The point where SMC curve cuts


AVC curve at the minimum is
called the firms shut down point
in the short run.
• In the long run minimum of
LRAC.
Normal profit
The level of profit which is just enough to
cover the explicit costs and opportunity
cost of the firm.
Here the revenue of the firm is just
sufficient to cover all its cost of production.

Break -even point


The point on the supply curve at which a firm
earns normal profit.
Determinants of supply
 Price of the commodity
 Technological progress
 Input prices
 Tax policy of the government
 Goals of the firm
 Nature of the market
 Expectations about future price
 Prices of other commodities
Impact of a unit tax on supply

 A unit tax is a tax that the government


imposes per unit sale of output.

 For example, suppose that the unit tax


imposed by the government is Rs 2. Then, if
the firm produces and sells 10 units of the
good.

 The total tax that the firm must pay to the


government is 10 × Rs 2 = Rs 20.
Supply function
Supply function shows the relationship
between the supply and the factors that
determine the supply.

S = f (x1, x2, x3…... xn)

S = f (p)

Law of supply : ‘other things being equal a


fall in price decreases the Qty supply and a
rise in price increases the quantity of
supply.’
Supply schedule
SUPPLY CURVE S
Price Quantity
supply 25

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

 Market supply is the total quantity of an


item producers are willing and able to
sell at different prices, over a given
period of time.
Market supply
Firm A Firm B Market supply
schedule
Price in Qunatity Price in Quantity Price in Quantity
Rs. Rs. Rs.
5 0 5 0 5 0

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.

Pes = proportionate change in supply /


proportionate change in price
Equilibrium under perfect
competition
Equilibrium means position of rest.
Under perfect competition both buyers and
sellers are price takers.
The price of a product is determined by its
supply and demand forces. This process is
known as price mechanism.
Adam smith calls this price mechanism as
invisible hand . Acc to him invisible hand is
always at work , if there is any imbalances
in the market, invisible hand guides the
market towards equilibrium.
The price at which quantity demand and
supply are equal is called equilibrium price.
In the perfect competition market, forces of
the market demand and market supply
determine equilibrium price at which both
the buyers and sellers are satisfied.
Equilibrium of market
Price in Quantity Quantity Y
Rs demand supply S
D
10 100 20
Excess
20 80 40 P3 supply
30 60 60
40 40 80 P2 E
50 20 100 P1

S Excess D
demand

0 Q1 Q2 Q3 X

You might also like

pFad - Phonifier reborn

Pfad - The Proxy pFad of © 2024 Garber Painting. All rights reserved.

Note: This service is not intended for secure transactions such as banking, social media, email, or purchasing. Use at your own risk. We assume no liability whatsoever for broken pages.


Alternative Proxies:

Alternative Proxy

pFad Proxy

pFad v3 Proxy

pFad v4 Proxy