Revenue of a firm, equilibrium

1. ANALYSIS OF REVENUE
Prof. Prabha Panth
Osmania University,
Hyderabad
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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.
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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.
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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
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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
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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.
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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
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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
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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.
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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.
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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
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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.
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13. Equilibrium of the firm
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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.
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15. Equilibrium of the firm - PC
R, C
0 q
TR
TC
A
q1
B
q2
R
C
q3
Max Profit
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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.
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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.
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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.
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19. Equilibrium - Monopoly firm
0
R
q
TR
TC
A
q1
B
q2q3
R
C
Max Profit
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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.
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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.
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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?
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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?
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