1. Chapter 6 Contemporary market capitalism: Output and price determination
Profits $
Revenue
Costs

2. Lecture Plan Price and output determination: perfect competition
Revenue (total, average, marginal)
Costs (fixed, variable, marginal)
Profit maximisation methods
Total revenue—total costs
Marginal revenue—marginal cost
Price and output determination in other market structures
Monopoly
Oligopoly
Monopolistic competition 2

3. Price and Output Determination: Perfect Competition
Market
Individual $P $P S D D P1 D D Q Q
Note: Demand can also be viewed as revenue for the firm

4. Revenue Total revenue: TR = P × Q where TR = total revenue P = price
Q = quantity
Average revenue: AR = TR ÷ Q
where AR = average revenue
TR = total revenue
Marginal revenue = the addition to total revenue from selling one extra unit

5. Demand and Revenue Schedule for a Perfectly Competitive Firm
Quantity demanded
Price
AR =
TR ÷ Q
TR = P × Q MR 12 -- 1 2 24 3 36 4 48 5 60 6 72

6. Demand and Revenue Curves for a Perfectly Competitive Firm70 TR 60 50 40 30 20
P = AR = MR = D 10 Q 1 2 3 4 5 6

7. Cost Analysis Short run Long run
Period of time where a firm is only able to increase output by using more of its existing factors of production, that is, a firm is restricted by a given amount of capital and labour
Long run
Period of time in which all factor inputs can be varied

8. Total cost (TC) = fixed costs (FC) + variable costs (VC)
Fixed costs: Costs
which, in the short run, do
not vary with the level of
output, e.g. initial plant and
capital equipment, rates
and government charges
which will occur even
before production begins
Variable costs: Costs which
increase as the level of output
is increased, e.g. costs for raw
materials and labour
Total cost (TC) = fixed costs (FC) + variable costs (VC)

9. Average and Marginal Costs
Average total cost: the total cost of producing divided by the number of units produced i.e.
ATC = TC
No. of units produced
Marginal costs: additions to total costs through producing one additional unit

10. Short Run Cost Schedule for a Perfectly Competitive Firm
Output units FC VC TC
ATC MC 7 – 1 6 13 2 11 18 9 5 3 25
8.3 4 29 36 48 55 19 68 75
12.5 90
As output increases, VCs also increase however not by constant amounts, that is, initially VC increases by smaller amounts, then by increasing amounts

11. The Law of Diminishing Returns (Decreasing Returns)
After a certain point, adding more variable factors of production causes a less than proportionate increase in the amount of extra output produced (this assumes that other factors are fixed/constant)
Note: Diminishing returns only occur in the short run when firms are unable to increase all factors in their correct proportions

12. Cost Curves for a Perfectly Competitive Firm80 40 $ 20 10 Q 6 3 1 2 4 5 TC VC FC MC

13. Profit Maximisation Short run profit maximisation for a perfectly
competitive firm
A firm must determine the level of output which will make the greatest profit
Two methods:
Total cost–total revenue method
Marginal cost–marginal revenue method

14. Total Cost–Total Revenue Method
Q FC VC TC TR Profit/Loss (TR – TC) –7 –1 –3
The greatest profit is $12 and occurs when there is an
output level of 4 units

15. Graphically P Q $ TR TC A B 4
Optimal production level at 4 units

16. Marginal Cost–Marginal Revenue Method
Where MR > MC (i.e. the revenue from producing another unit is more than the cost of making it)
Firms can increase profits by producing more
Where MC > MR (i.e. the cost of making the last unit exceeds the revenue gained by selling it)
Firms can increase profits by reducing output
Where MC = MR, profit is maximised

17. Example Profit maximising level at 4 units, MR is greater than
Q MC MR Difference –7 –8
Profit maximising level at 4 units, MR is greater than
MC but they are almost equal

18. Graphically P MC MR Q Level of profit maximisation is where
Level of profit maximisation is where
MC = MR i.e. where the curves intersect

19. Price and Output Determination: Monopoly
Public utilities (Australia Post, old Telecom)
Barriers to entry
Control over essential raw materials
Patents/copyrights
Tariffs, quotas, subsidies
Size of the market
Economies of scale

20. Demand Curve for the Monopolist (Same as That for the Total Market)Q Q

21. Price and Output Determination: Monopoly
Marginal revenue is less than the selling price
The price that the monopolist charges for the product is indicated by the demand curve
Monopolists are price makers and they can charge prices above the level of a perfectly competitive firm

22. Price and Output Determination: Monopolistic Competition
Monopolistic competition places constraints on the ability of a firm to charge prices in excess of competitors
However, firms in this market structure engage in considerable non-price competition (e.g. product differentiation) in order to be able to charge a higher price than competitors

23. Price and Output Determination: Oligopoly
The ‘kinked’ demand curve
P ($)
D1(A,B,C) DA P3 D
Firm’s demand if competitors
don’t follow price change P2 P1
demand if competitors
follow price change
D1 for industry DA Q Q2
Q1A
Q1(A,B,C)