Mic 8

Microeconomics All Rights Reserved
© Oxford University Press Malaysia, 2008
8– 1

CHAPTER

8 Theory of Firm
8– 2

CONCEPT OF REVENUE
TOTAL REVENUE (TR)
The total amount received from the sale of a firm’s goods and services.
Total Revenue (TR) = Price (P) x Quantity (Q)

AVERAGE REVENUE (AR)
Average revenue is the total revenue per unit output sold.

Average revenue (AR) is also equal to the price (P) of the good.

Average Revenue (AR) = Total Revenue (TR)
Quantity (Q)
AR = P x Q = PRICE
Q

8– 3

CONCEPT OF REVENUE
MARGINAL REVENUE (MR)
The change in total revenue resulting from one unit increase in quantity sold.
Marginal Revenue (MR) = Change in Total Revenue
Change in Quantity
MR = ∆ TR/ ∆ Q

(3) (4) (4)
(1) (2)
Total Revenue Average Revenue Marginal Revenue
Quantity Price
(1)X(2) (3) / (1)
∆ (3) / ∆ (1)
10 50 500 50 50
20 45 900 45 40
30 40 1200 40 30
40 35 1400 35 20
50 30 1500 30 10
60 25 1500 25 0
70 20 1400 20 -10
8– 4

CONCEPT OF REVENUE
Case I: Imperfect Market
Quantity Price Total Revenue Average Revenue Marginal Revenue
(TR) (AR)
10 10 100 10 (MR)
10
20 9 180 9 8
30 8 240 8 6
40 7 280 7 4
50 6 300 6 2

15
AR equals to price but MR is less
Price than the price when the price
AR, MR

10 changes.
Price
AR The graph shows that AR and
5
MR are downward sloping and
MR
MR curve lies below the AR
0 10 20 30 40 50 Quantity curve.

8– 5

CONCEPT OF REVENUE (CON’T)
Case II: Perfect Market
Quantity Price Total Revenue Average Revenue Marginal Revenue
(TR) (AR)
10 10 100 10 (MR)
10
20 10 200 10 10
30 10 300 10 10
40 10 400 10 10
50 10 500 10 10

15 AR, MR and price are same
Price
AR, MR

10 when the price is constant.
AR The graph shows the
5 horizontal line at a price
MR of RM10 which indicates that
0 10 20 30 40 50 Quantity
MR = AR = Price.

8– 6

CONCEPT OF REVENUE BY
EQUATION
Given demand curve as: P = a – bQ (b is the slope)
TR = P x Q
= (a – bQ) x Q
= aQ – bQ2
Derivation of MR from demand curve
MR = dTR/dQ
MR = a – 2bQ (MR is ½ of the slope of DD)

8– 7

DIFFERENCES BETWEEN ECONOMIC
PROFIT AND ACCOUNTING PROFIT
Economic Profit Accounting Profit
 Economic profit is defined  Accounting profit is
as the total revenue minus defined as the firm’s total
the implicit and explicit revenue minus the explicit
cost. cost.
 Considers explicit and
implicit cost.  Considers only explicit
cost
 πEC = TR – [Explicit Cost +
Implicit Cost]  πAC = TR – Explicit Cost

MICROECONOMICS 88– 8

DEFINITION OF A FIRM

A firm is an institution that buys or hires
factors of production and organizes them to
produce and sell goods and services.
A firm is an independent unit producing
goods and services for sale.

8– 9

OBJECTIVES OF A FIRM

The main goal or objective of a
firm is to maximize profit and to
minimize the cost.

8– 10

TOTAL REVENUE USING
THE TOTAL COST APPROACH
Case I: Perfect Market
(1) (2) (3) (4) (5)
Quantity Price Total Revenue Total Cost Profit
(Q) (P) (TR) (TC) (TR - TC) Using Table:
0 300 0 100 -100 Profit maximization is
1 300 300 500 -200 determined by
2 300 600 0
scanning through the
600
profit at each level, and
3 300 900 100
800 the level which gives
4 300 1200 250
9500 the highest profit is the
5 300 1500 350
1150 profit maximizing
6 300 1800 400 output.
7 1400
300 2100 400
8 300 2400 2100 300
9 300 2700 2700 0
10 300 3000 3100 -100

8– 11

TOTAL REVENUE USING
TOTAL COST APPROACH (CON’T)

TR, TC

TC Using Graph:
TR TR curve is a straight line through
the origin.
The maximum profit is where the
Highest vertical difference is the highest.
vertical
differences

Quantity

8– 12

TOTAL REVENUE USING
Case II: Imperfect Market

(1) (2) (3) (4) (5)
Quantity Price Total Revenue Total Cost Profit
(Q) (P) (TR) (TC) (TR - TC) Using Table :
0 340 0 200 -200 Profit maximization is
1 340 340 400 -60 determined by
2 330 660 100
scanning through the
560
profit at each level,
3 320 960 260
700 and the level which
4 310 1240 440
800 gives the highest profit
5 300 1500 600
900 is the profit maximizing
6 290 1740 700 output.
7 1040
280 1960 760
8 270 2160 1200 760
9 260 2340 1800 540
10 240 2400 2400 0

8– 13

TOTAL REVENUE USING

TR, TC

TC
Using Graph :
TR TR curve is increasing and after
the profit maximizing output, the
curve starts to decline.
Maximum profit is where the
Highest
vertical difference between TR and
vertical
TC is the highest.
differences

Quantity

8– 14

MARGINAL REVENUE USING
MARGINAL COST APPROACH

Quantity Price Marginal Marginal
(Q) (P) Revenue Cost
(MR) (MC)
Using Table:
0 300 300 400 Profit maximizing
1 300 300 200 output level is obtained
2 300 300 100 following the
3 300 300 150 MR = MC rule.
4 300 300 200
5 300 300 250
6 300 300 450
7 300 300 300
8 300 300 400
9 300 300 600
10 300 300 700

8– 15

MARGINAL COST APPROACH (CON’T)
MR, MC

MC Using Graph:
MR curve is perfectly elastic or
horizontal to the price.
P* MR The profit maximization rule,
MR = MC, where the MC curve
intersect with the
MR curve.

Quantity
Q*

8– 16


Quantity Price Marginal Marginal
(Q) (P) Revenue Cost
(MR) (MC)
Using Table:
0 340 Profit maximizing
1 340 340 200 output level is obtained
2 330 320 160 following the
3 320 300 150 MR = MC rule.
4 310 280 200
5 300 260 250
6 290 240 450
7 280 220 300
8 270 200 400
9 260 180 600
10 240 60 700

8– 17

MR, MC

MC
Using Graph:
MR curve under
imperfect market is
P* downward
sloping as the output
increases.
AR=P
The profit maximization
rule, MR = MC, where
the MC curve intersect
MR with the MR curve.
Quantity
Q*

8– 18

TYPES OF MARKET STRUCTURE
MONOPOLISTIC MONOPOLY
COMPETITION
There are large numbers of sellers There is a single seller and a
and large number of buyers. large number of buyers. Sellers
Sellers sell differentiated products sell products that has no close
due to branding and labelling, subsitute and has a high entry
and there are no barriers and exit barrier.
to entry and exit. TYPES OF
TYPES OF
MARKET
MARKET
PERFECT COMPETITION STRUCTURE OLIGOPOLY
STRUCTURE
There are a large number of There are only a few firms in
buyers and sellers, buying and the industry, but large number
selling identical product without of buyers. Products can be
any restrictions on entry and exit either identical or differentiated,
and having perfect knowledge of and there are barriers to
the market at a time. entry and exit.

8– 19

TYPES OF MARKET STRUCTURE
(CON’T)
Market Structure

Characteristics Perfect Monopolistic Oligopoly Monopoly
competition competition

Number of firms Very large number Large number Few One

Type of firms Homogenous Dfferentiated Homogenous or Unique: no close
differentiated substitutes
Conditions to Very easy Easy Significant Entry not
Entry obstacles possible
Control over Price taker Price taker Independent Price maker
price
Promotion No Yes Yes Noor little
strategy
Demand curve Horizontal Downward slope Kinked Downward slope

8– 20

Mic 8

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