Author: John Bouman

The Four Industry Types An industry can be classified in one of four market types: 1. Pure competition. Pure competition is a market structure in which there are many competing firms selling identical products or services. Very few, if any, industries in the real world are purely competitive, because it is believed that each company is unique and has at least a very small amount of monopoly power. Economists still find it useful to analyze this market structure, because it allows us to better understand the other three more-realistic market structures. We learn about pure competition in this unit. The farming industry is very competitive, and is highlighted in Section 7 as an example of this market structure. 2. Monopoly. A monopoly is an industry with only one seller. The product that the firm sells has no close substitutes. Monopolies can be firms that are granted exclusive production rights by a government. They can also be firms that have attained monopoly powers through efficient free market production methods and economies of scale. We analyze monopolies in Unit 7. 3. Monopolistic competition. Monopolistic competition is a market structure in which there are many small firms selling slightly differentiated products or services. Monopolistic competition is different from monopoly. The emphasis in monopolistic competition is on “competition.” In a monopoly industry, there exists no or very little competition. In a monopolistically competitive...

Total Revenue A firm’s total revenue is equal to the price of the product times the number of products sold. For example, if you own a publishing company and you sell 100 books at $14 per book, then your total revenue is 100 x $14 = $1,400. Total Costs Total costs equal the firm’s total variable costs (labor, supplies, raw materials, etc.) plus the firm’s total fixed costs (machinery, office space, etc.). For example, if your firm’s total variable costs equal $500, and your total fixed costs equal $300, then your total costs equal $500 + $300 = $800. Total Profit Total profit is total revenue minus total costs. In the above example, your firm’s profits equal $1,400 – $800 = $600. Abbreviations We will use the following abbreviations: Total Revenue = TR Total Cost = TC Total Profit = TP The Price of the Product = P The Quantity of the Product Sold = Q Calculations We will use the following equations to calculate TR and TP: TR = P x Q TP = TR – TC In the example at the top of this page: TR = P x Q = 100 x $14 = $1,400 TC = $800 so TP = TR – TC = $1,400 – $800 =...

Average Revenue Average revenue is revenue per product. For example, if your firm’s total revenue is $200, and you are selling 100 products, then your average revenue is $200 divided by 100, or $2. Marginal Revenue Marginal revenue is the additional revenue from selling one more product. Let’s say that your firm’s total revenue is $200 when you sell 100 products, and your total revenue is $220 when you sell 110 products. Then your marginal revenue is $20 (the additional revenue) divided by 10 (the additional production), which equals $2. Abbreviations We use the following abbreviations: Average Revenue = AR Marginal Revenue = MR Total, Average, and Marginal Revenue Curves In Unit 2, we learned that if the supply of a product increases, its equilibrium price decreases. However, one firm in pure competition makes up a very small part of the entire industry. Therefore, if this one firm’s quantity sold increases, it will have an insignificant effect on the price. In the above example, the purely competitive firm increases its quantity sold from 100 to 110. If the other firms in the industry do not increase their quantity supplied, then the market supply does not increase significantly, and we can assume that the price remains constant at $2. Note that if the price is constant, then the average revenue and marginal revenues equal the price. Below is a table...

Combining Revenue and Costs In the previous sections in this unit, we analyzed revenue curves. In order to calculate profit, we also need to know the firm’s costs. Using the revenue data and graphs from the previous section and adding typical marginal, average, and average variable cost curves for our magazine firm, we can draw the following graph: The Profit Maximizing Rule In any industry, a firm maximizes profits at the point where its marginal cost equals its marginal revenue. Mathematicians use calculus and derivatives to prove this. For an explanation of this proof, see the footnote at the bottom of this page. Understanding the Profit Maximizing Rule We can also understand the profit maximizing rule intuitively. In the graph below, Qpm is the profit maximizing quantity. If the firm produces at a point to the left of Qpm (for example, the point at which marginal cost is at its minimum), then we notice that marginal cost is less than marginal revenue. The marginal revenue is $2. The marginal cost at the minimum MC point is at approximately $0.50. By producing this quantity, the firm will add $1.50 to its profit compared to producing the quantity before. Moving a little bit to the right of this quantity, we notice that marginal cost rises to, for example, $1. Shall we produce this quantity over the quantity where MC was $0.50?...

Combining Revenue and Costs in a Table In the previous section, we analyzed profit maximization by studying graphs. In this section, we will analyze a purely competitive firm’s profit maximizing quantity based on data from a table. The Firm’s Costs Let’s look at the following hypothetical firm’s cost data. Quantity Total Fixed Cost Total Variable Cost Total Cost Marginal Cost Average Variable Cost Average Total Cost 0 $50 $0 $50 – – – 1 50 30 80 $30 $30 $80 2 50 50 100 20 25 50 3 50 60 110 10 20 36.67 4 50 68 118 8 17 29.50 5 50 80 130 12 16 26 6 50 100 150 20 16.67 25 7 50 130 180 30 18.57 25.71 8 50 165 215 35 20.63 26.88 9 50 220 270 55 24.44 30 The Firm’s Revenue Case A: The Market Price is above the Firm’s Average Total Cost Let’s assume that the market price is $31. Because this firm is a purely competitive firm, marginal revenue and average revenue are also $31. Looking at the table above, we can see that at various quantities, the price exceeds the average total cost. This means that at these quantities, the firm will make a profit. The Firm’s Profit Maximizing Quantity In the previous section, we concluded that a firm maximizes its profits where marginal revenue equals marginal cost....