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Profit Maximisation at MR MC: An Open Source Education Project
Profit Maximisation at MR MC: An Open Source Education Project
Revenue
Total revenue = Price × Quantity
Average revenue = Price = Demand
Marginal revenue is the change in the firms total revenue resulting from a change in its
sale by one unite
• The shape of the MR curve reflects the shape of a firm’s DD curve
• The MR curve is always below a firm’s DD curve
Profit Maximization
Normal Profits Accounting Profit = Implicit Cost Zero economic profit
Supernormal Accounting Profit > Implicit Costs Positive economic profit
Profits
Subnormal Accounting Profit < Implicit Costs Negative economic profit
Profits
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An Open Source Education Project
Microeconomics | Firms | 2
http://education.helixated.com
An Open Source Education Project
Microeconomics | Firms | 3
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An Open Source Education Project
Microeconomics | Firms | 4
E XT E R N A L E C O N O M I E S O F S C A L E
EEOS are the savings in average costs that occur to all firms in an industry as a result of
expansion of the industry, or the concentration of firms in a certain location (LRAC shifts
down)
Economies of Concentration: More firms located in the same area derive mutual
benefit
Availability of Skilled Labour – increased demand for particular skills give benefits
• Educational institutions set up
• Joint development of research and training facilities
Well developed infrastructure – Better infrastructure is set up to cater for economies of
concentration
Reputation – large, well established industries builds up a name which customers
associate with quality
1. Brand loyalty, steady clientele
Economies of Disintegration: Creation of subsidiary industries to cater to need of a
major industry
Economies of Information: Publication of trade journals increase productivity of
individual firms
E XT E R N A L D I S E C O N O M I E S O F S C A L E
EDOS are increases in average costs that occur to all firms in an industry as a result of
the expansion of the industry or the concentration of firms in a certain location. (LARC
shifts up)
Increased strain on infrastructure: Infrastructure will be taxed to its limits
2. Congestion, increased fuel consumption
Rising costs of FOPs: Growing industries may create a shortage of RMs or skilled
labour
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An Open Source Education Project
Microeconomics | Firms | 5
GROWTH OF FIRMS
MEASURING GROWTH
1. Quantity of output sold
2. Turnover (total annual revenue)
3. Market share
4. Capital stock (amount of real assets)
5. Number of employees
METHODS OF GROWTH
Internal Expansion: Making more of a product, or extending a firm’s product range
Mergers & Acquisitions: Forming of new enterprises by the merging with, or taking
over of one or more existing firms.
1. Vertical Integration
o Merger between firms engaged in different stages of a production process
Backward integration (oil refineries buying oil wells)
Forward integration (breweries buying pubs)
2. Horizontal Integration
o Usually an acquisition of firm(s) at the same stage of production in the
industry
Market dominance due to reduced competition
Greater specialization and economies of scale
3. Conglomeration
o Mergers involving firms which are not directly related to each other
Diversify output
Reduce risks of trading
Ensure long term growth
MOTIVES FOR GROWTH
See “Measuring Growth”
1. Exploit EOS
2. Gaining market share
3. Security through economies of scope
4. Increase market valuation
5. Reduce chances of acquisition by another firm
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An Open Source Education Project
Microeconomics | Firms | 6
The Theory of Contestable Markets shows how monopolies or near monopolies may
practice competitive pricing due to low barriers to entry and exit
• The market for low cost carriers is extremely contestable (~$10m investments)
The concentration ratio of an industry measures the output of an industry largest firm
(or firms) as a proportion of the industry’s total output.
• For PC, the concentration ratio extremely low
• For a monopoly, the concentration ratio is almost 100%
Market saturation refers to the situation in which a product has become diffused within
a market. A diffused product is one that is available to almost all consumers, or more
applicably, almost all households, for example the refrigerator or an automobile. Market
growth is constrained and demand cannot be stimulated when a market is saturated.
The factors affecting market saturation include
• Consumer purchasing power and prices
• Competition
• Technology (dynamic efficiency)
• Product life cycles (when products will get replaced by newer products)
• Population growth
PRICE DISCRIMINATION
Price discrimination is the situation where (a) a producer sells a good to different
buyers at two or more different prices or (b) when the same consumer is charged
different prices for the same product for reasons not associated with cost differences.
C O N D I T I O N S N E C E S S A RY F O R P R I C E D I S C R I M I N AT I O N
1. Control over market supply
2. Ability to segment the market without possibility arbitrage
3. Market segments must have different PEDs
T Y P E S O F P R I C E D I S C R I M I N AT I O N
First degree Second degree (block Third degree
pricing)
Each customer is charged Different prices are charged Same product sold at
his reservation price (the for different blocks of the different prices to different
maximum price they are same good. customers.
willing to pay)
Auctions Utilities, taxi fare Admission tickets to parks,
etc.
C O S T S A N D B E N E F I T S O F P R I C E D I S C R I M I N AT I O N
Costs
1. Loss of consumer surplus
Benefits
1. Higher output
2. Higher profits for the firm
3. Provision of goods that would otherwise not be produced
a. With PD, a firm may be able to cover costs
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