6.2 THE INDIVIDUAL BUSINESS AND THE INDUSTRY

Question 1

THE INDIVIDUAL BUSINESS AND THE INDUSTRY

Answer 1

• Individual businesses form a small part of the market, therefore, they do not influence market price. Individual business is a price taker.
• Market price is determined by the interaction of demand and supply.
• DD (demand curve) slopes downwards from top left to bottom right and SS
(supply curve) slopes upwards from bottom left to top right.
• The point where demand and supply intersect, is called the equilibrium.
• Individual business can offer any quantity on the market at the market price.
• Business will not charge a higher price, because buyers will buy elsewhere and
they will not charge a lower price, because they can sell all their goods at the current market price.

Question 2

DEMAND CURVE FOR INDIVIDUAL BUSINESS

Sketch A Sketch B

Answer 2

Sketch B
• •
• •
Demand curve for individual business is a horizontal line at market price. For each unit sold, business receives the same price – the market price, Therefore P1 = AR = MR equals individual demand curve.
The average revenue the business receives is therefore equal to the market price and the horizontal demand curve represents the average revenue curve (AR).
The revenue from any additional unit the business sells, that is the marginal revenue, is equal to market price P1, and the horizontal demand curve therefore also represents the marginal revenue curve (MR).

Question 3

Profit maximization

Total Cost (TC) and Total Revenue (TR)

Answer 3

• Between 0 and 3 units the firm makes a loss (TC is greater than TR).
• At 3 units the firms economic profit is zero.
• Between 3 units and 8 units the firm makes economic profit.
• At 8 units the firm makes zero profit.
• Beyond 8 units the firm is making a loss (TC is greater than TR)

Question 4

Marginal cost (MC) and Marginal Revenue (MR)

Answer 4

When
MR ˃ MC (marginal revenue greater than marginal cost) = output should increase MR = MC (marginal revenue equals marginal cost) = profit is maximized
MR ˂ MC (marginal revenue lower than marginal cost) = output should be reduced

Question 5

Supply of the business

Answer 5

• Under perfect competition profits are maximized where SMC = MR and it is used to derive business’s supply curve
• The different market prices are taken to determine how much a business would produce at each price.
• The production determines the supply curve.
• Average variable cost (AVC) consists of the per unit value of e.g. labour cost,
material cost, fuel and electricity cost, etc.

Question 6

THE INDUSTRY

The industry’s short term supply curve

Answer 6

• The short term supply curve is also called the market supply curve.
• The market supply curve of the industry is derived by horizontally adding up the
quantity supplied (at a particular price) of individual businesses.
• The market is used as a synonym for the industry.

Question 7

THE INDUSTRY

The industry’s short term equilibrium

Answer 7

• The industry is in equilibrium at a price that clears the market.
• That is at a price where the quantity demanded is equal to the quantity supplied.
• Short term equilibrium of the industry will not apply in the long term.
• Businesses that make economic profit in the short term will have to expand their
businesses in the long term.
• As a result of economic profit, more businesses will be attracted to the industry.
• Businesses that make losses and who are unable to adjust their business will have to close in the long term.