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Analysis of Revenue

Revenue of a firm, equilibrium

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Analysis of Revenue

  1. 1. ANALYSIS OF REVENUE Prof. Prabha Panth Osmania University, Hyderabad 17-Apr-16 17/04/2016Prabha Panth
  2. 2. REVENUE  The earnings of a firm, are called its Revenue.  It equals Quantity sold into the Price of the product:  Total Revenue TR = P × Q  When a firm sells more output, given price, its TR increases.  Thus total revenue increases with sales. 217/04/2016Prabha Panth
  3. 3. Revenue and Market structure  TR = P × Q  But P fixation depends on the market.  Different markets have different types of P fixation . 1. In Perfect Competition, the market determines P, and all firms have to sell at this P. Uniform P. 2. In Imperfect Markets (monopoly, oligopoly and monopolistic competition), P is fixed by individual firms. So P need not be the same for all firms in such markets. 317/04/2016Prabha Panth
  4. 4. Revenue in Perfect Competition  In Perfect Competition, P is determined by the market D and S.  All firms here have to sell at the same P.  At this P there is infinite D for its product.  If any firm increases P, then it loses its customers to other firms,  There is no need to lower P, as there is infinite D at the given P.  Therefore in the short run, P remains constant in P.C. ceteris paribus 417/04/2016Prabha Panth
  5. 5. Total Revenue - P.C firm P (Rs) Q (kgs) TR= P×Q (Rs) 10 0 0 10 1 10 10 2 20 10 3 30 10 4 40 10 5 50 10 6 60 517/04/2016Prabha Panth
  6. 6. Total Revenue – P.C firm R 0 q TR=P×q As P is constant, increase in q, leads to increase in Total Revenue. TR is thus a straight line through the origin. 617/04/2016Prabha Panth
  7. 7. Average and Marginal Revenue  Average Revenue AR = TR/Q AR = TR = P × Q = P Q Q So AR = P. The AR curve shows the relationship between P and Q. Therefore it is also the demand curve of the firm.  Marginal Revenue MR = change in TR due to change in Q. MR = ∆TR ∆Q 717/04/2016Prabha Panth
  8. 8. TR, AR and MR in Perfect Competition P (Rs) Q (kgs) TR= P×Q AR = TR/Q MR =∆TR/∆Q 10 0 0 0 0 10 1 10 10 10 10 2 20 10 10 10 3 30 10 10 10 4 40 10 10 10 5 50 10 10 10 6 60 10 10 817/04/2016Prabha Panth
  9. 9. TR, AR and MR - PC firm R q 0 TR=P×q P =10 AR=MR = d When q=0, P=10, and remains constant, as q increases. AR = MR = P for a perfectly competitive firm. A straight line parallel to X - axis. 917/04/2016Prabha Panth
  10. 10. Price in Imperfect Competition  In imperfect markets – monopoly, oligopoly and monopolistic competition, the firm is free to fix its own P.  There is no market P, but individual Ps.  To sell more the firm has to lower its P.  Therefore the AR curve will be sloping downwards.  TR will not increase continuously, but will dip downwards after a maximum. 1017/04/2016Prabha Panth
  11. 11. Revenue in Imperfect Competition P (Rs) Q (kgs) TR= P×Q AR = TR/Q MR =∆TR/∆Q 10 1 10 10 10 9 2 18 9 8 8 3 24 8 6 7 4 28 7 4 6 5 30 6 2 5 6 30 5 0 4 7 28 4 -2 3 8 24 3 - 4 1117/04/2016Prabha Panth
  12. 12. TR, AR and MR in imperfect competition R 0 q TR AR = d TR max MR TR is an inverted U-shaped curve. AR is downward sloping. MR is also downward sloping. It lies below AR, cuts X-axis when TR is maximum, And then becomes negative. 1217/04/2016Prabha Panth
  13. 13. Equilibrium of the firm 1317/04/2016Prabha Panth
  14. 14. Equilibrium of the firm  How much of output should the firm produce and sell?  As Q increases, TR, but TC also .  A rational firm tries to maximise its profits, or minimise loss.  Assuming that cost curves are given, Profit = TR – TC This refers to all types of markets, Perfect and Imperfect. 1417/04/2016Prabha Panth
  15. 15. Equilibrium of the firm - PC R, C 0 q TR TC A q1 B q2 R C q3 Max Profit 1517/04/2016Prabha Panth
  16. 16. Equilibrium of the firm - PC  As Q increases, TR and TC both increase.  Up to point A, TC > TR, so the firm runs at a loss.  At A, TC = TR, this is called the “break even” point of the firm, profits = 0.  Beyond A, TR >TC, so the firm makes profit, till point B.  At point B, again the firm makes zero profits, as TC = TR.  After B, TC > TR and the firm makes losses. This is the uneconomical zone of production. 1617/04/2016Prabha Panth
  17. 17. Equilibrium of the firm - PC  How much of output should the firm produce to make maximum profits?  This will lie between points A and B.  The output that fetches it maximum profit, is the point where the difference between TR and TC is the maximum,  To find this point, draw a tangent to the TC curve that is parallel to TR curve.  This point (q3) gives the maximum profit (R- C).  This is a unique point, as no other level of output will give the firm maximum profit. 1717/04/2016Prabha Panth
  18. 18. Equilibrium in Monopoly (imperfect market)  The same principles of profit maximisation applies in all imperfect markets.  Taking monopoly as an example,  The shape of the TR curve is different in monopoly,  It is an inverted U-shaped curve.  Assuming that TC curve has the same shape, profit maximising output has to be decided. 1817/04/2016Prabha Panth
  19. 19. Equilibrium - Monopoly firm 0 R q TR TC A q1 B q2q3 R C Max Profit 1917/04/2016Prabha Panth
  20. 20. Profit Maximisation - Monopoly Firm  At A and B, the firm makes no profit, as TR = TC.  As in PC, the maximum profit is the largest distance between TR and TC.  This is found at the output where the slope of the TR = slope of TC.  Shown by drawing tangents to the two curves, and locating that point where the two tangents are parallel.  Profit maximising output = q3. 2017/04/2016Prabha Panth
  21. 21. Profit Maximising Conditions  For all types of firms, profit maximising output is fixed at the point where: 1) Slope of TR = slope of TC. Slope of TR = MR, and slope of TC = MC. So for profit maximisation, the first condition is that MC = MR. But there could be more than one point where this will occur. 2) The second condition for profit maximisation is that the rate of increase in MC > rate of increase in MR. That is MC should be rising while MR should be falling. So an extra unit of output adds more to TC than to TR, making it unprofitable to increase output. Thus the two conditions for determining the profit maximising output of a firm are: 1. MC = MR, and 2. MC should cut MR from below. 2117/04/2016Prabha Panth
  22. 22. Questions 1. Short answer questions: a) What is “revenue”? How does it differ from Price and Cost? b) What is the shape of the TR curve of a perfectly competitive firm? Illustrate. c) What are AR and MR? How are they derived? 2. Essay questions: a) Depict TR, AR and MR of a monopoly firm in a diagram. What is the reason for their respective shapes? 2217/04/2016Prabha Panth
  23. 23. b) What are the two conditions of profit maximisation? Illustrate with a diagram. c) How does a firm in P.C achieve maximum profits? Show with the help of a diagram. d) With the help of a diagram show how a monopoly firm achieve maximum profits? 23 17/04/2016 Prabha Panth