L12 - Revenues and Profit Maximsation

Question 1

What is a price taker?

Answer 1

• A seller is a price taker if it can sell as much as it wants at a given price
• a Buyer is a price taker if it can buy as much as it wants at a given price
• Price takers are small compared to the size of the market

Question 2

What is a price maker?

Answer 2

• A seller is a price maker if the amount it sells affects the market price
• A buyer is a price maker if the amount it buys affects the market price

Question 3

What does the TC,TR and π curve look like?

Answer 3

• the TR curve is a incline line
• the TC is a x^3 curve which goes up, then down and up again
• the π curve is a negative X^2 curve that occurs at the bottom of the graph intercepting the x axis at q’ and q’’
• Normal Profit –> The firm breaks even if it produces q’ or q’’ OR TC=TR
• Supernormal Profit –> The firm’s total revenue is greater than its costs - occur at any point between q’ and q’’ with the maimum distance between the TC and TR curve or the maximum point on the π being the largest amount of Supernormal profit that can be earnt

Question 4

How do you calculate Average Revenue?

Answer 4

• How much revenue does the firm get on average?This is the amount that the firm earns per unit of output sold
  AR = TR/Q
  AR = price

Question 5

How do you calculate Marginal Revenue?

Answer 5

How much revenue does the firm get for the last unit?This is the extra revenue of selling one more unit of output
MR = ∆TR/∆Q
= TR{Q+1} –TR{Q}

Question 6

What does the Average and Marginal Revenue Curves look like for a price taking firm?

Answer 6

• Since a firm can sell any amount at a given price, the average revenue curve and the Marginal revenue curve is horizontal
• also equal to price
• This is also a price-taking firm’s demand curve

Question 7

What is the Shut-down rule?

Answer 7

Short-run
- A firm will shut down if average variable costs are larger than price:
p < AVC
- Since some factors cannot be varied: A firm must pay its fixed costs whether it
shuts down or not.
- If TR covers the TVC, then it is able to pay off some of its TFC.

Long run:
All factors are variable, so all costs are variable (there are no fixed costs)
p < LRAC (average total cost)

Question 8

In the short-run when will the firm be making supernormal profits?

Answer 8

• A firm makes supernormal profit in the short run if p > ATC (AVC + AFC)
• A firm makes a loss in the short run if p < ATC
• But it should not shut down in the short run if p ≥ AVC

Question 9

What is the marginal output rule?

Answer 9

• If the firm does not shut down, then it should produce at the level where:
• (marginal revenue) MR = MC (marginal cost)
• Why? Recall that when an extra unit is produced:
• the amount that TR (total revenue) increases by is MR
• the amount that TC (total cost) increases by is MC
• If MR > MC, then producing an extra unit increases TR more than TC

Thus, the firm’s profits increase (since π = TR – TC)

Question 10

When are Losses minimised?

Answer 10

Losses are minimised at the

point where MR = MC

Question 11

Why are supply curves upwards sloping?

Answer 11

• As price increases, the quantity supplied by the firm increases…
• This implies that the firm’s
  supply curve slopes upwards