The Origin of the Demand and Total Revenue Curves of a Firm in a Competitive Industry

THE ORIGIN OF THE DEMAND AND TOTAL REVENUE CURVES OF A FIRM IN A COMPETITIVE INDUSTRY.

The commodity we will use here is Christmas trees.

The industry price is set by supply and demand in the market. The total quantities are tens of thousands of Christmas trees.

The price set in this market is $10.00

The quantity is 70,000 trees.

At the industry price, the individual firm can sell all they wish without noticeably altering the industry price. Note that the firm’s output is a tiny fraction of total industry output.

The total revenue of the firm is the price ($10) times the quantity sold. The total revenue increases at $10 for each tree sold. As a result the total revenue of the firm is a straight line with a slope equal to the price, $10. This slope is the marginal revenue of the firm. The marginal revenue and the price of a firm in a competitive market are the same.

PROFIT MAXIMISING WITH TOTAL COST AND TOTAL REVENUE CURVES

When output is zero, the total costs are $820. These are the TFC of the firm. As output rises the firm must use more and more variable factors, so the total variable costs, and therefore the total costs of the firm will rise. Because of diminishing returns, eventually the total costs rise at an increasing rate.

Profit = TR – TC Where TR is less than TC the firm makes a loss. A loss occurs when output is 100 units or less and when output is 1400 units or more.

Profit is maximised when output is 800 units. It is $1780. Total cost is $6220 and Total revenues are 8000.

Profit maximising output can be found more easily using the average cost curves. Losses are made whenever the price is less than the average total cost. So losses are made when output is less than 100 units or 1400 units or more.

The firm makes a profit when price is greater than average total costs. It makes a profit here when output is between 100 and 1400 units.

At every output where the revenue earned from one more unit, the price, is greater than the addition to cost of producing one more unit, the marginal cost, the firm will increase profits by producing that unit. At every output where the revenue earned from one more unit, the price, is greater than the addition to cost of producing one more unit, the marginal cost, the firm will decrease profits by producing that unit. As a result, the firm maximises profits by producing where price equals marginal cost. P = MC. At that output, production has expanded to the point where any additional output will reduce profits.

Profit is maximised when output equals 800 trees. Price is, as always in this example, $10. Marginal cost is $10. Average total costs is $7.78. The profit per unit is $2.22. total profit is $1780.

See table belos: At an output of 800 Christmas trees, this tree farmer maximises profit at $1,780. (She could make the same profit at 700 units, but we always produce the extra unit. Possibly profit is slightly higher at 750 units.)

DETERMINING PROFIT MAXIMISING OUTPUT FROM TABLES