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The Theory of The Firm Under Perfect Competition

Concept of Revenue

Objectives

After going through this chapter, you shall be able to understand the following concepts.

  • Concept of Revenue
  • Types of Revenue- Total Revenue, Average Revenue and Marginal Revenue
  • Relationship between Total Revenue, Average Revenue and Marginal Revenue under Perfect and Imperfect Competition  

Introduction

Revenue is the money income for a firm which it receives from the sale of goods produced. In other words, revenue refers to the sale proceeds or sales receipts. Generally, the firm sells its goods at the price which covers its cost of producing the goods along with some margin known as profit. In other words, profit is the difference between the selling price and cost of producing a product. That is:

Revenue = Cost + Profit

or, Profit = Revenue Cost

Types of Revenue

There exist mainly three types of revenue, viz.

  1. Total Revenue
  2. Average Revenue
  3. Marginal Revenue

Total Revenue (TR)

It is defined as the total sale proceeds of a producer by selling corresponding level of output. It can also be defined as price times the quantity of output sold. That is:

TR = Price × Quantity of output sold

or, TR = P × Q

i.e. TR = PQ

Average Revenue (AR)

It is defined as revenue earned per unit of output sold. AR is same as that of price of the output. For example, if price of an output is Rs 5 and the total quantity sold is 10 units, then

TR = P × Q

or, TR = 5 × 10 = Rs 50

i.e. AR = Price of the output = Rs 5

Marginal Revenue (MR)

It is defined as the change in the total revenue due to sale of one more unit output. It is calculated by either of the two following ways.

1. MR

        

2. MRn = TRnTRn–1

where,

MRn represents Marginal Revenue due to nth unit of output

TRn represents Total Revenue of n units of output

TRn–1 represents Total Revenue of n –1 units of output

Example: If a firm has TR of Rs 100 by selling 10 units of output and TR of Rs 110 by selling 11 units of output, then the change in TR due to the sale of one extra unit (from 10 to 11) is Rs 10 (i.e. Rs 110 – Rs 100). Thus, Rs 10 is the change in TR of Rs 100 by selling the 11th unit of output. 

Algebraically,

MRn = TRnTRn–1

MR11 =TR11TR10 = Rs 110 – Rs 100 = Rs 10

Or 

Relationship between TR, AR and MR

In order to understand the relationship between TR, AR and MR, first of all we need to learn about the types of AR and MR curves faced by firms under different market structures. For time being, let us limit ourselves to this point only that under perfect competition, an individual firm faces a horizontal demand curve for its product. The same demand curve represents AR and MR curve. That is, in other words the demand curve, AR curve and MR curve are the same curve under perfect competition firm and are drawn as the horizontal line parallel to x-axis. On the other hand, under imperfect competition market structure (whether monopoly, monopolistic or oligopolistic market), a firm faces a downward sloping demand curve and has different AR and MR curves. Under imperfect competition, AR and MR are two different curves both sloping downwards with MR being less elastic (steeper) and AR is relatively more elastic (flatter).

The relationship between TR, AR, MR differs in two types of markets i.e. Perfect and Imperfect competition. This point will be more clear once we are through with different types of market structures.

Relationship between TR, AR and MR- Under Perfect Competition Market

Output

(units)

Price = AR

(in Rs)

TR = P × Q

(in Rs)

MRn = TRnTRn–1

(in Rs)

1

5

5

5 – 0 = 5

2

5

10

10 – 5 = 5

3

5

15

15 – 10 = 5

4

5

20

20 – 15 = 5

5

5

25

25 – 20 = 5

  1. Under perfect competition market, AR equals MR throughout all output levels.
  2. TR curve is a linear positively sloped line from the origin.
  3. The increase in TR is in the same proportion as the increase in the output sold.
  4. MR curve is a straight horizontal line parallel to the x-axis and coincides with the AR curve.

Relationship between TR, AR and MR- Under Imperfect Competition Market

 

Output

(units)

Price = AR

(in Rs)

TR = P × Q

(in Rs)

MRn = TRnTRn–1

(in Rs)

1

10

10

10 – 0 = 10

2

9

18

18 – 10 = 8

3

8

24

24 – 18 = 6

4

6

24

24 – 24 = 0

5

4

20

20 – 24 = –4

 

  1. When TR curve is increasing at diminishing rate, MR curve is falling but remains positive.
  2. When TR curve attains its maximum point 'K', MR curve touches the x-axis and becomes zero.
  3. When TR curve starts falling, MR curve becomes negative.
  4. AR curve is a downward sloping and is falling throughout all levels of output. The AR curve remains above the MR curve.
  5. When TR curve touches the x-axis and becomes zero, the AR curve also becomes zero and the MR curve is negative.

Objectives

After going through this chapter, you shall be able to understand the following concepts.

  • Concept of Market and its Forms
  • Perfect Competition Market and its various features
  • Pure Competition Market and its various features   

Introduction to the Concept of Market

In economics, the concept of market is comparatively broader than what it usually means as. It is not only limited to a geographical location known as mandi or bazaar but also implies the presence of buyers and sellers, presence of commodity or product that the buyers and sellers are ready to compete with each other to buy and sell. Now-a-days, with the advancement in technology such as, online transactions, etc. the concept of market has become even wider. Think of online booking of movie tickets, telephonic booking of table at restaurant, etc. one need not to visit the exact place of market (cinema hall or restaurant) for purchase and sell. It can be done from anywhere and anytime. Thus, with the time yet to come, the concept of market will become more sophisticated and complex.

Before proceeding, let us understand the meaning of market, firm and industry.

Meaning of Market, Firm and Industry


1. Market: Market acts as a medium which provides a platform, where buyers and sellers are brought into contact with each other in order to exchange (buy and sell) goods  and services.

2. Firm: Firm basically refers to an individual production unit operating under an industry.

3. Industry: Industry refers to the collection of all the production units or firms that produce the same product.

Features of Market

The following are the basic features of a market.

1.      Buyers- It refers to those who demand a commodity to fulfil their satisfaction.

2.      Sellers- It refers to those who produce goods in order to sale and to earn profits.

3.      Commodity- It refers to the existence of tangible or intangible commodities and services, which the sellers wants to sell and the buyers wants to buy.

4.      Area- It refers to the place where both the buyers and the sellers can contact each other and interact.

5.      Competition- There must be some sought of competition among the buyers’ and the sellers to buy and sell commodity in the market. The competition among the buyers raises prices (as demand is more), while the competition among sellers leads price to fall (as supply is more).

Forms of Market

In order to understand the forms of market, let us first analyse the factors on which the market structure depe...

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