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Traditional theory 1. MR = AR
Profit maximisation
1. MC = MR
Alternative theories
Managerial theories
Behaviourial theories
Total Revenue (TR)
1. A variety of goals, eg. production, sales, market share,
1. Straight line from origin
profit
2. Aim to achieve a satisfactory performance for each goal
Perfect markets
Imperfect markets
Profits
Normal profit
1. TR = TC
2. Zero economic profit
3. No incentive for firms to leave or new ones to enter
Supernormal profits
1. MC = MR
2. Since P = MR, P = MC. Firm is allocative efficient.
1. TR > TC
2. Firms earns more than opportunity costs
Total approach
3. Entry of firms will depend on ease of entry
a. If barriers exist, profit level remains high 1. Point where vertical difference between TR and TC is the
b. If no entry barriers, profit level goes down to greatest
normal profit
Subnormal profits
4. TR < TC
5. Firms makes less than opportunity cost
6. Firms will cease production when
a. Revenue < Variable Cost, firm leaves in
short run
b. Revenue > Variable Cost, firm continues in
short run but leaves in long run
Perfect Competition
Supernormal Profits
1. Homogeneous products
2. No barriers to entry, hence a large number of small firms
3. Firms have no market power, price takers
Revenue Curves
New firms will enter → Industry’s supply increases → Price falls Evaluation of Perfection Competition
until normal profit
Pros
Normal Profits
1. Allocative efficient, sum of consumer surplus and producer
surplus is maximum
Subnormal Profits
Cons
Monopoly
Barriers to Entry
1. Cost condition
a. Highly capital-intensive
b. Minimum efficient scale occurs at high
output
2. Legal barriers
3. Contrived barriers
a. Control of input supplies
b. Brand loyalty
Revenue Curves
Two effects:
Equilibrium
2. Allocatively efficient as in 1st degree
Pros
Supernormal profits due to:
Evaluation of Monopoly
Pros
1. Cost advantage
a. Economies of scale and R&D will lead to lower MC
b. Price can be lower and output (MC = MR) can be
higher than allocative efficient level of PC (P =
MC)
c. Lower MC → Larger consumer surplus
2. Research and development
3. Lower cost despite not producing at minimum efficient scale
Shaded area = Supernormal profits as MC is lower
A practice of firms charging different prices for the same 1. Allocatively inefficient
products, unsupported by cost reasons 2. Higher price, lower output
a. Production at MC = MR and not P = MC
Conditions Necessary
b. Loss of consumer surplus
3. Income inequality
Controlling Monopolies
Monopolistic Competition
Characteristics
Revenue Curve
1. Supernormal profits
1. Higher price
2. Lower output
3. Higher AC
Characteristics
1. Differentiated products
2. Restricted entry of new firms
3. Few large firms
a. Two firms - Duopoly
4. Interdependence among firms
Non-collusive
Pros
Cons
1. R&D
1. Allocative inefficient (P > MC)
2. Product differentiation
2. Excess capacity between LR output ant MES output
3. Lack of R&D
Cons
Comparison between Monopolistic Competition and
1. Allocatively inefficient (P > MC)
Perfect Competition
2. Wastage of resources
3. Smaller scale of production compared to monopoly
4. Firms may collude and behave as a monopoly
Non-Price Competition
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