THEORY OF FIRM & MARKET STRUCTURE

THEORY OF THE FIRM & MARKET STRUCTURES

1. INTRODUCTION

The firm

A firm is an organization that combines all resources for the production of

goods and service. i.e. Eon.

The industry

An industry is a group of firms that produces similar products or sells output in

the same market. i.e. manufacturing industry such as textile, soaps and foods
and servicing industry such as medical, legal and construction.

Definition of market

A market exist when buyers and sellers meet; it can be in the form of an actual
meeting place such as night market, through telecommunication media or
printed materials

The market structure

- A market structure is the way in which an industry is organized.

The types of market structure can be classified according to the number
of firms in the industry and the types of product manufactured. There are
4 types of market structure:

• PERFECT COMPETITION,
• MONOPOLISTIC COMPETITION,
• OLIGOPOLY &
• PURE MONOPOLY

- SO………………THE THEORY OF FIRMS & MARKET

STRUCTURES IS TO DETERMINE THE PRICE AND OUTPUT TO
BE PRODUCED IN THESE FOUR MARKETS!

2. OBJECTIVE OF A FIRM

2.1. Conventional perspective

• to maximize profit

• production efficiency
THEORY OF FIRM & MARKET STRUCTURE

2.2. Islamic perspective

• Full compliance with the Islamic idea of justice

• Welfare consideration into entrepreneurial decisions

• Profit maximization within the limits set by the operation of

above principles

3. DETERMINATION OF EQUILIBRIUM OF A FIRM

Definition of equilibrium of the firm

- Equilibrium output is the output level, which gives the maximum

economic profit. (Highest efficiency and lowest cost)

- There are 2 approaches to maximize the profit

1. Aggregate approach
(total revenue and total cost)

PROFIT = TOTAL REVENUE (TR) – TOTAL COST (TC)

Quantity Price TR TC Profit

1 10 10 15 -5
2 10 20 20 0
3 10 30 28 2
4 10 40 35 5
5 10 50 46 4
6 10 60 58 2
7 10 70 70 0
8 10 80 82 -2

Price / cost $ TC
TR

B
LOSS
TR : 40
PROFIT(TR-TC)
TC : 35
A
LOSS

0 2 4 7 Output
THEORY OF FIRM & MARKET STRUCTURE

♫ conclusion : the vertical difference between the TR and TC curves gives

profit at each level of production. At lower levels of output, the firm will
incur a loss. As production increases, profits increase and eventually
reaching a maximum level at output 5. If the firm were to produce
more than 5, profits would decline.

2. Marginal approach
(marginal revenue and marginal cost)

MARGINAL REVENUE (MR) = MARGINAL COST (MC)

• Using the marginal approach, equilibrium output is when the

MR of producing an additional unit of a good equals its MC

QUANTITY PROFITS MR MC
0 -300 0 -
10 -200 20 10
20 -50 20 5
30 120 20 3
40 250 20 7
50 350 20 10
60 380 20 17
70 400 20 20
80 200 20 40

• from the table we can see the relationship between MR and

MC are shown as follow:

i. MR > MC = increase in output will increase profit.

Shown by the profit level from output 10 to 60

ii. MR < MC = increase in output will lower the profit. This

is shown by the profit level at output 80

iii. MR = MC = profit is maximized. Shown by the profit

level at output 70.

• this marginal analysis / approach therefore shows that a firm

can continue to increase profits up to the point at which MR = MC.
THEORY OF FIRM & MARKET STRUCTURE

• Graphically:

MR/MC MC

20 F E MR
A B

0 10 30 70 80 QTY

♫ Based on the graph above, the firm maximizes profit when it produces 70
unit because at this output MR = MC = 20. This is shown at equilibrium
point E

WHY POINT E?

♫ at point F, MR = MC too, however this is not the profit maximization

situation. The output produced that is 10 units is a starting point to get
economic profit. Below that output firm will incur cost (at beginning
stage only fixed cost) and leads to loss

♫ at 30 units, MR > MC, the firm attains economic profit. If the firm stops
production at 30 unit, the profit attained is area A only and forgone the
other half at area B

4. PERFECT COMPETITION

A. Definition
Perfect Competition is an ideal market structure characterized by :
- A very large number of buyers and sellers,
- It is a PRICE TAKER, each buyer and seller has no control over the
market price and takes whatever price determined by the market
B. Characteristics

Main factor Characteristics

1. The number of buyer and
seller
2. Types of product sold
3. Barriers to entry
4. Control over price
Many buyer and sellers
Homogenous @ standardized product
Free entry and exit without restrictions from
the relevant authorities
Price taker & quantity setter (can control
quantity but cannot control price)
THEORY OF FIRM & MARKET STRUCTURE

5. Perfect knowledge
6. Mobility of factors of
production
7. Non-price competition
C. The Demand Curve
Both the buyers and the sellers have perfect
knowledge of the market condition.
It is assumed that if a seller increases his price,
the other sellers and buyers will come to know
about it.
Perfect mobility of factors of production
without the firm incurring additional costs
Perfect @ extreme competition

- the demand curve for perfect competitive firm is perfectly elastic curve
@ horizontal straight line
- this is because in perfect competition there’re too many sellers and we
called it price taker (seller has no control over price)
Price

DD = AR = MR

Quantity
 THEORY OF FIRM & MARKET STRUCTURE

Types of Normal profit @ zero Economic profit @ Loss @ subnormal profit

profit profit (TR=TC) supernormal profit (TR<TC)
(TR>TC)
Main point
1. Definition * Define as minimum * Supernormal profit is * Subnormal profit is a
profit required for the a situation where the situation where the
firm in the market or the perfect competition perfect competition firms
situation where a firm’s firms TR greater than TR smaller than its TC
TR = TC its TC
* Known as zero profit or
break-even profit
2. Condition to i. Equilibrium, i. Equilibrium, i. Equilibrium,
attain profit MR = MC = P MR = MC = P MR = MC = P
ii. AR = AC ii. AR > AC ii. AR < AC
iii. TR = TC iii. TR > TC iii. TR < TC
3. Diagram

* Firm equilibrium is at * Firm equilibrium is at

 THEORY OF FIRM & MARKET STRUCTURE

point E because point E because

MR=MC=P * Firm equilibrium is at MR=MC=P
* Pe is $5 and Qe is 10 point E because * Pe is $5 and Qe is 10
unit MR=MC=P unit
* AR ($5) = AC ($5) * Pe is $5 and Qe is 10 * AR ($5) = AC ($6)
unit
(AR ($5) = AC ($4 *
4. Calculation TR = Pe * Qe = 5*10 = TR = Pe * Qe = 5*10 = TR = Pe * Qe = 5*10 = 50
50 50 TC = AC * Qe = 6*10 =
TC = AC * Qe = 5*10 = TC = AC * Qe = 4*10 = 60
50 40 Loss = TR – TC = 50–60
π = TR – TC = 50 – 50 π = TR – TC = 50–40 = -10 (EGIK)
=0 = 10 (EFGH)
5. Conclusion A firm which attains The firm that attains In short run, the firms
normal profit @ zero economic profit in that incurs a loss will or
profit will not leave the short run will continue will not leave the market
market operation in the depending on its ability to
market; this situation cover its TVC. If it can
will attract new firms to cover the TVC, the firms
join them. will continue the
operation. If it cannot, it
will leave the market; this
situation will not attract
new firms to join the
THEORY OF FIRM & MARKET STRUCTURE

market.
THEORY OF FIRM & MARKET STRUCTURE

Shut down point @ exit

Definition
- Shut down point for a firm is one where price is just equal to its
AVC or below AVC
- The firm will shut down or not its operation depending on its
short run AVC and AR

Condition
i. If P < AVC

- The firm should shut down

ii. If P > AVC

- The firm should continue its operation even at a loss

iii. If P = AVC

- The firm should shut down

Diagram

i. If P < AVC

MC
AC

AVC
THEORY OF FIRM & MARKET STRUCTURE

- The firm should shut down because it cannot cover its variable
costs.

ii. If P > AVC

MC AC

AVC

- The firm should continue its operation even at a loss

because it can still cover all its variable costs and
some fixed cost as well

iii. If P = AVC
MC AC

AVC

- The firm are advisable to shut down

- Incur loss equals to its TFC
THEORY OF FIRM & MARKET STRUCTURE

D. Profit maximization in the long run

- in the long run, the firm can only earn NORMAL PROFIT
because of:

i. Free entry
- mean that new firms may enter the industry if it established
SUPERNORMAL PROFITS
- the entry of more firms into the industry will increase the
market supply and reduces the market price
- this adjustments continues until economic profits normal profit
in the long run
P P

Q Q
THEORY OF FIRM & MARKET STRUCTURE

ii. Exit
- mean that some of the existing firms will leave the market if
there’re facing SUBNORMAL PROFIT in the industry
- the exit of existing firm from the industry make the remaining
firms reduce their production as well as supply and price rises
- this adjustment continues until normal profit in the long run

P P

Q Q

5. MONOPOLY

A. DEFINITION

Monopoly is a market structure where

- only a single seller (PRICE SETTER)
- produce a unique product (no close substitutes for the
monopolist product)
- impossible entry into the market

Example in Malaysia, telecommunication service (Telekom), airline system

(MAS) and natural gas (PETRONAS)
THEORY OF FIRM & MARKET STRUCTURE

B. CHARACTERISTICS

Main factor Characteristics

1. The number of buyer and
seller
2. Types of product sold
3. Barriers to entry
4. Control over price
5. Perfect knowledge
6. Mobility of factors of
production
7. Non-price competition
Single sellers
Unique product
Impossible to entry from the aspect of
* granting of special license and franchise
* existence of patent and copyright
* the high initial cost
* resource ownership
Price maker ( can control price @ quantity
but not both)
Considerable
Considerable
No competition because only firm in the
market (sole seller)

C. THE DEMAND CURVE

- Monopolist facing a downward sloping demand curve because

the monopolist is a price maker (power to control price not
quantity), meaning it must decrease the price to sell more.

- The TR OF MONOPOLY IS NOT A STRAIGHT LINE like

perfect competition, but it will initially increase then reach the
maximum and finally fall

- AR for the monopoly is DOWNWARD SLOPING and it is

important to note that AR = DEMAND CURVE = P @ the
price setting of the product. It shows that to increase more
outputs the seller must reduce its price (P Q , P Q ).

- MR is also DOWNWARD SLOPING and it is always LESS

THAN AR.
THEORY OF FIRM & MARKET STRUCTURE

P M
Maximum

TR

E>1

E=1

E<1
AR=P=D
MR Q

D. REASONS OF MONOPOLY
D.1. Monopoly arises due to:

1. Granting of special license and franchise

2. Existence of patent and copyright
3. High initial cost
4. Resource ownership
5. Cartel
D.2 Barriers to entry in Monopoly:
1. High initial cost
2. Legal prohibition
3. Cut throat competition
4. Climatic conditions
5. Granting of special license and franchise
6. Existence of patent and copyright

E. SHORT RUN EQUILIBRIUM

- in the short run, monopolist can either earn
THEORY OF FIRM & MARKET STRUCTURE

i. Normal profit
ii. Supernormal profit
iii. Subnormal profit
 THEORY OF FIRM & MARKET STRUCTURE

Types of Normal profit @ zero Economic profit @ Loss @ subnormal profit

profit profit (TR=TC) supernormal profit (TR<TC)
(TR>TC)
Main point
1. Definition * Define as minimum * Supernormal profit is * Subnormal profit is a
profit or the situation a situation where the situation where the
where a firm’s TR = TC monopolist TR greater monopolist TR smaller
* Known as zero profit or than its TC than its TC
break-even point
2. Condition to iv. Equilibrium, iv. Equilibrium, iv. Equilibrium,
attain profit MR = MC = P MR = MC = P MR = MC = P
v. AR = AC v. AR > AC v. AR < AC
vi. TR = TC iii. TR > TC iii. TR < TC
3. Diagram

* Firm equilibrium is at * Firm equilibrium is at

point E because point E because
MR=MC=P * Firm equilibrium is at MR=MC=P
 THEORY OF FIRM & MARKET STRUCTURE

* Pe is $5 and Qe is 10 point E because * Pe is $5 and Qe is 10

unit MR=MC=P unit
* AR ($5) = AC ($5) * Pe is $5 and Qe is 10 * AR ($5) = AC ($6)
unit
(AR ($5) = AC ($4 *
4. Calculation TR = Pe * Qe = 5*10 = TR = Pe * Qe = 5*10 = TR = Pe * Qe = 5*10 = 50
50 50 TC = AC * Qe = 6*10 =
TC = AC * Qe = 5*10 = TC = AC * Qe = 4*10 = 60
50 40 Loss = TR – TC = 50–60
π = TR – TC = 50 – 50 π = TR – TC = 50–40 = -10 (EGIK)
=0 = 10 (EFGH)
5. Conclusion The monopolist is The monopolist is The monopolist is earning
earning Normal profit earning supernormal subnormal profit @ loss
profit.
THEORY OF FIRM & MARKET STRUCTURE

F. LONG RUN EQUILIBRIUM

- in the long run, a monopolist can earn and be able to maintain a

SUPERNORMAL PROFIT
- the main factor is due to the EXISTENCE OF BARRIERS to
entry into the market

LRMC

LRAC

A
Pe
B
C
E

LRMR LRAR

Qe Q

- monopolist in equilibrium when LRMR = LRMC at point E

- Equilibrium price and quantity is at Pe and Qe
- At this point, the LRAR > LRAC, which gives the supernormal
profit to the monopolist shows by area PeABC

G. COMPARISON BETWEEN MONOPOLY AND PERFECT

COMPETITION
- Before comparison are made, first we assumed that
i. the comparison is made in the long run
ii. initially, the firm is a perfect competition and
eventually turns into monopoly
- Comparison between monopoly and perfect competition based
on:
1. Long-run profit
2. Price & quantity
THEORY OF FIRM & MARKET STRUCTURE

3. Efficiency
P

MC

AC

Pm
Z Ep
Pp
Arp = MRp = Pp
= Dp
Em

MRm ARm = Pm = Dm

Qm Qp Q

1. Long-run profit
- perfect competition earns a normal profit
- monopoly earns a supernormal profit
2. Price & Quantity
- equilibrium point is achieved when MR = MC for both
monopoly (at Em, Pe = Pm & Qe = Qm ) and perfect
competition ( at Ep, Pe = Pp & Qe = Qp )
- the equilibrium price for monopoly is higher compared to
perfect competition (Pm > Pp). This is because monopolist is a
price maker rather than perfect competition is a price taker.
- the equilibrium output for monopoly is lower than perfect
competition (Qm < Qp).
3. Efficiency
- allocation of resources is efficient in perfect competition
because the equilibrium output (Qp) is produced at minimum
average cost known as optimum output
THEORY OF FIRM & MARKET STRUCTURE

- for monopoly, resources are not allocated efficiently because

the output produced (Qm) at higher average cost where the
average cost is decreasing (point Z)
H. PRICE DISCRIMINATION
a. Definition
- Price discrimination refers to the practice of charging different
prices to different consumers for a same good or service
b. Objectives
- to maximize its profit through the increasing sales by taking
advantage of different elasticity in different markets
c. Conditions for price discrimination
i. The seller must be a monopolist
- or posses at least a power to control the price in the market such
as an oligopolist
ii. The seller must be able to separate the market
iii. Elasticity of demand must be different
iv. Cost to separate must be as low as
possible
d. Types of price discrimination
- there’re 3 types of price discrimination in monopoly;

• First degree price discrimination

- occurs when a firm charges s different price for each unit sold
and charges each consumer the maximum price that he or she is
willing to pay for each unit
- i.e. in the case of an auction fair

• Second degree price discrimination

- occurs when the products are grouped into blocks and each
block is charged at a different price
- i.e. Photostat

• third degree price discrimination

THEORY OF FIRM & MARKET STRUCTURE

- charging different prices in different markets i.e. male vs female

(hair-cut services), TNB charge different prices to different
group of customers, where for industry users is much more
lower compared to household users

6. MONOPOLISTIC COMPETITIVE MARKET

A. DEFINITION

A market structure characterized by

- large number of producers
- producing similar but not identical product (differentiated)
- easy market entry and exit

There are many brand names which substitutes for each other but each is
slightly differentiated either by its quality, packaging, etc thus allowing some
price differentials. Examples of such products are soap, toothpaste, ice-
cream etc.

B. CHARACTERISTICS

Main factor Characteristics

1. The number of buyer and
seller
2. Types of product sold
3. Barriers to entry
Many sellers
Differentiated product
Free entry & exit
- but the entry may not easy as it is
under perfect competition because
the new firms will have to come up
with new product features and
brands to establish their reputations

4. Control over price
5. Perfect knowledge
6. Mobility of factors of
production
7. Non-price competition
Price maker but with limited power to control
over price
Considerable
Considerable
Significant because sellers cannot really
compete in terms of price but the seller will
compete from the aspect of packaging,
advertising, branding and product quality
THEORY OF FIRM & MARKET STRUCTURE

C. THE DEMAND CURVE

- the demand and marginal revenue curve for a monopolistically

competitive firm is downward sloping because price is a
variable factor since each firm has a considerable control over
its price
- but the demand curve is more elastic compared to monopolist
because in monopolistically competitive market, there are many
available substitutes since the product is similar

Price

MR AR

Output

D. SHORT RUN EQUILIBRIUM

- in short run, Monopolistically competitive may earn 3 types of

profit:

i. Normal profit @ zero profit (TR-TC)

ii. Economic profit @ supernormal profit (TR>TC)
iii. Loss @ subnormal profit (TR < TC)
 THEORY OF FIRM & MARKET STRUCTURE

Types Normal profit @ Economic profit Loss @

of profit zero profit @ supernormal subnormal profit
(TR=TC) profit (TR>TC) (TR<TC)
Main
point
1. * Define as * Supernormal * Subnormal
Definition minimum profit profit is a profit is a
or the situation situation where situation where
where a firm’s the monopolistic the monopolistic
TR = TC TR greater than TR smaller than
* Known as zero its TC its TC
profit or break-
even point
2. vii. Equilibri vi. Equilibri vi. Equilibriu
Condition um, um, m,
to attain MR = MR = MR = MC
profit MC = P MC = P =P
viii. AR = AC vii. AR > AC vii. AR < AC
ix. TR = TC iii. TR > iii. TR < TC
TC
3.
Diagram

* Firm * Firm
equilibrium is at equilibrium is at
*
point E because Firm point E because
MR=MC=P equilibrium is at MR=MC=P
point E because
* Pe is $5 and * Pe is $5 and Qe
MR=MC=P
Qe is 10 unit is 10 unit
* Pe is $5 and
* AR ($5) = AC * AR ($5) = AC
($5) Qe is 10 unit ($6)
AR ($5) = AC *
(($4
4.Calculat TR = Pe * Qe = TR = Pe * Qe = TR = Pe * Qe =
ion 5*10 = 50 5*10 = 50 5*10 = 50
TC = AC * Qe = TC = AC * Qe = TC = AC * Qe =
 THEORY OF FIRM & MARKET STRUCTURE

5*10 = 50 4*10 = 40 6*10 = 60

π = TR – TC = π = TR – TC = Loss = TR – TC =
50 – 50 50–40 50–60
=0 = 10 (EFGH) = -10
(EGIK)
5.Conclusi The The The monopolistic
on monopolistic is monopolistic is is earning
earning Normal earning subnormal profit
profit supernormal @ loss
profit.

Price

LRAC
LRMC

P = AC

LMR P = LAR = DD

0 Qe Quantity

E. LONG RUN EQUILIBRIUM

- in long run, the monopolistic competition firm earns a

NORMAL PROFIT ONLY because of short run profit that’s :

i. supernormal profit

- supernormal profit in the short run will attracts new firms to the
market with similar but not identical products
- this will lead to a higher supply of production and caused the
price go down
THEORY OF FIRM & MARKET STRUCTURE

- the process continues until the existing firms earn only normal
profit

ii. subnormal profit

- subnormal profits in the short run will case firms to exit/leave

the industry
- this will lower the supply and caused the price to increased
the process continues until it reaches a level which enables the
existing firms to earn normal profits
THEORY OF FIRM & MARKET STRUCTURE

7. OLIGOPOLY

A. DEFINITION

Oligopoly is a market structure that’s characterized by

- a few larger firm dominate the market
- produce either homogenous or differentiated product
- difficult and quite impossible to entry
- each firm behavior depends on the behavior of the other firms in
the industry
examples the markets for tobacco, automobiles, steel and aluminum

B. CHARACTERISTICS

Main factor Characteristics

1. The number of buyer and A few large sellers
seller
2. Types of product sold Homogenous or differentiated product
3. Barriers to entry Various barriers to enter this market and
compete with an oligopolies from the aspect
of
* economics of scale
* control of important raw material
* big advertising outlays
* patented products
4. Control over price Considerable
5. Perfect knowledge Considerable
6. Mobility of factors of Considerable
production
7. Non-price competition Solely non-price competition, the price war is
totally avoided & non-price competition in
terms of better service, advertising, research
and development
8. Interdependence Mutual interdependence, is a condition in
which an action by one firm may cause a
reaction from other firms
THEORY OF FIRM & MARKET STRUCTURE

C. THE DEMAND CURVE

- known as Kinked Demand Curve Model (Sweezy’s model)

- this model explain stability in price and why an oligopolistic
firm is facing a kinked demand curve
- kinked demand curve explain why prices under oligopoly
- the demand curve for an oligopolies is based on these 2
assumptions:

1. if a firm increase its price, others will

not follow because they do not want
losing their customers. The elastic
portion of the demand curve can show
this.

2. if a firm reduces its price, others will

follow because they do not want loss a
market share. The inelastic portion of
the demand curve can show this.

- mean that oligopolist will faces 2 dd curves that’s:

i. demand for his product
ii. demand for industry product

Price D
d

17,000

15,000 P0 E

12,000

D d

0 1.5 3 3.2 5

Quantity
THEORY OF FIRM & MARKET STRUCTURE

(million)
dd = demand for is own product (elastic)
DD = demand for the industry’s or market product (inelastic)
- diagram above shows the kinked demand curve, Pe is 15,000
and Qe is 3 million
- if the firm raises its price from 15,000 to 17,000 other firm will
not follow because they will lose customer in the market where
the quantity demand of their product will decreases from 3 to
1.5 million. This is shown on elastic demand curve dd
- if the firm lowers its price from 15,000 to 12,000, other firms
will follow because they want to avoid losing share in the
market to the firm which is lowers the price lowering the price
from 15,000 to 12,000 will increase quantity demanded from 3
to 3.2 million. This is shown on inelastic demand curve DD
- so the actual demand curve for oligopolies is a combination of
the elastic and inelastic portion of the demand curve known as
KINKED DEMAND CURVE shown by dED
- so…………it’s clear that oligopolistic firm is faced with
kinked demand curve where DD = AR = P
- Because of AR curve is kinked, the MR curve will be
discontinuous line and even though MC may increase or
decrease i.e. at MC or MC1, MC is still equal to MR at the same
level of output
P

Pe

MC

MC1

AR = DD = P
THEORY OF FIRM & MARKET STRUCTURE

Qe Q

MR

D. THE FIRMS EQUILIBRIUM

Price

Pe
MC1

A MC2

B e1

e2 AR = D = P

Qe MR Quantity

- to maximize profit, oligopolist will not involve in price

competition, they will try to minimize cost of production as
lower as possible and Pe & Qe can achieve by MR = MC

- REMEMBER! Because of AR curve is kinked, the MR curve

will be discontinuous line and even though MC may increase or
decrease i.e. at MC or MC1, MC is still equal to MR at the same
level of output

- Kink in demand curve creates a break in the MR that’s a

b gap. In between a-b gap,
• fluctuation of MC does not effect the Pe & Qe
• MC from MC1 to MC2 , Pe & Qe REMAINS
CONSTANT (this explains about the PRICE RIGIDITY – price
usually remains unchanged for a long period of time)
THEORY OF FIRM & MARKET STRUCTURE

- From the above diagram, at higher MC that’s MC1 the

output produced is Qe and price is Pe and the profit is area A

E. SHORTRUN EQUILIBRIUM

- in short run, oligopolistic may earn 3 types of profit:

i. Normal profit @ zero profit (TR-TC)

ii. Economic profit @ supernormal profit (TR>TC)
iii. Loss @ subnormal profit (TR < TC)
 THEORY OF FIRM & MARKET STRUCTURE

Types of Normal profit @ zero Economic profit @ Loss @ subnormal profit

profit profit (TR=TC) supernormal profit (TR<TC)
(TR>TC)
Main point
1. Definition * Define as minimum * Supernormal profit is * Subnormal profit is a
profit or the situation a situation where the situation where the
where a firm’s TR = TC oligopolistic TR greater oligopolistic TR smaller
* Known as zero profit or than its TC than its TC
break-even point
2. Condition to i. Equilibrium, i. Equilibrium, i. Equilibrium,
attain profit MR = MC = P MR = MC = P MR = MC = P
ii. AR = AC ii. AR > AC ii. AR < AC
iii. TR = TC iii. TR > TC iii. TR < TC

3. Diagram

* Firm equilibrium is at * Firm equilibrium is at

 THEORY OF FIRM & MARKET STRUCTURE

point E because point E because

MR=MC=P * Firm equilibrium is at MR=MC=P
* Pe is $5 and Qe is 10 point E because * Pe is $5 and Qe is 10
unit MR=MC=P unit
* AR ($5) = AC ($5) * Pe is $5 and Qe is 10 * AR ($5) = AC ($6)
unit
(AR ($5) = AC ($4 *
4. Calculation TR = Pe * Qe = 5*10 = TR = Pe * Qe = 5*10 = TR = Pe * Qe = 5*10 = 50
50 50 TC = AC * Qe = 6*10 =
TC = AC * Qe = 5*10 = TC = AC * Qe = 4*10 = 60
50 40 Loss = TR – TC = 50–60
π = TR – TC = 50 – 50 π = TR – TC = 50–40 = -10 (EGIK)
=0 = 10 (EFGH)
5. Conclusion The oligopolistic is The oligopolistic is The oligopolistic is
earning Normal profit earning supernormal earning subnormal profit
profit. @ loss
THEORY OF FIRM & MARKET STRUCTURE

- If firms becomes more efficient, MC decrease from MC1

to MC2 , the output is still at the same Pe & Qe but the profit has
increased to area A + B. So…….without changing the price, the
firm can maximize profit by reducing the cost through
efficiency in production.

- CONCLUSION, kinked demand curve model predicts

that P & Q will be INSENSITIVE to small cost changes but
will respond if cost changed are large enough

F. LONG-RUN EQUILIBRIUM

- In the long run oligopolistic firm will earn

SUPERNORMAL PROFIT because BARRIRES TO ENTRY

Price
MC

Pe
AC

AC

AR=P=D

Qe MR Q