Question

Explain Total Revenue, Average Revenue and Marginal Revenue with the help of a diagram. OR How are quantity and price determined under perfect competition? Explain.

Hint:

Remember that in perfect competition, the firm has no pricing power. The price is a "given" from the market. The only decision the firm makes is "how much" to produce at that given price.

Answer 1

Step 1: Definitions:
\begin{itemize} \item Total Revenue (TR): It is the total amount of money a firm receives from the sale of its output. It is calculated as Price (P) multiplied by the quantity of output sold (Q). \[ TR = P \times Q \] \item Average Revenue (AR): It is the revenue per unit of output sold. It is calculated by dividing Total Revenue (TR) by the quantity of output sold (Q). AR is always equal to the price of the good. \[ AR = \frac{TR}{Q} = \frac{P \times Q}{Q} = P \] Therefore, the AR curve and the demand curve are the same. \item Marginal Revenue (MR): It is the additional revenue generated from the sale of one more unit of output. \[ MR_n = TR_n - TR_{n-1} \] \end{itemize}

Step 2: Relationship and Diagram (under Imperfect Competition):
The relationship between TR, AR, and MR is typically shown for a market with imperfect competition (like monopoly or monopolistic competition), where a firm must lower its price to sell more units. \begin{itemize} \item Both AR (price) and MR curves are downward sloping. \item The MR curve lies below the AR curve and declines at a faster rate. \item When TR is increasing, MR is positive. \item When TR is at its maximum, MR is zero. \item When TR starts falling, MR becomes negative. \end{itemize} \begin{center} \begin{tikzpicture}[scale=1] % Upper panel for TR \begin{scope}[yshift=4cm] \draw[->] (0,0) -- (8,0) node[right] {Output (Q)}; \draw[->] (0,0) -- (0,4) node[above] {Total Revenue (TR)}; \draw[thick, color=blue] (0,0) .. controls (2,3.5) and (4,4) .. (5,4); \draw[thick, color=blue] (5,4) .. controls (6,3.9) and (7,3.5) .. (8,2); \node[above] at (5,4) {Max TR}; \node at (2.5, 3) {TR}; \draw[dashed] (5,4) -- (5, -2); \fill (5,4) circle (1.5pt); \end{scope} % Lower panel for AR and MR \begin{scope}[yshift=0cm] \draw[->] (0,0) -- (8,0) node[right] {Output (Q)}; \draw[->] (0,-2.5) -- (0,3) node[above] {AR, MR}; \draw[thick, color=red] (0,2.5) -- (8,0.5) node[right] {AR (Demand)}; \draw[thick, color=green] (0,2.5) -- (5,0) -- (8,-1.5) node[right] {MR}; \fill (5,0) circle (1.5pt); \node[below] at (5,0) {MR=0}; \end{scope} \end{tikzpicture} \end{center} Solution (Price and Quantity Determination under Perfect Competition):

Step 1: Understanding Perfect Competition:
Under perfect competition, there are a very large number of buyers and sellers of a homogeneous product. No single buyer or seller can influence the market price. The industry is the price-maker, and the individual firm is the price-taker.

Step 2: Determination of Price and Quantity by the Industry:
The market price and quantity are determined by the intersection of the market demand curve and the market supply curve. \begin{itemize} \item Market Demand Curve (DD): Slopes downwards, showing that consumers will buy more at a lower price. \item Market Supply Curve (SS): Slopes upwards, showing that producers will supply more at a higher price. \end{itemize} The equilibrium price is the price at which quantity demanded equals quantity supplied. The equilibrium quantity is the quantity bought and sold at this price.

Step 3: Explanation with Diagram:
\begin{center} \begin{tikzpicture}[scale=0.8] \draw[->] (0,0) -- (6,0) node[below] {Quantity}; \draw[->] (0,0) -- (0,5) node[left] {Price}; \draw[thick, color=blue] (1,4) -- (4,1) node[right] {DD (Market Demand)}; \draw[thick, color=green] (1,1) -- (4,4) node[right] {SS (Market Supply)}; \draw[dashed] (2.5, 2.5) -- (2.5, 0) node[below] {Q* (Equilibrium Quantity)}; \draw[dashed] (2.5, 2.5) -- (0, 2.5) node[left] {P* (Equilibrium Price)}; \fill (2.5,2.5) circle (2.5pt) node[right]{E (Equilibrium Point)}; \end{tikzpicture} \end{center} In the diagram, the market demand curve DD and the market supply curve SS intersect at point E. \begin{itemize} \item P* is the equilibrium price determined by the market. At this price, the market clears (no shortage or surplus). \item Q* is the equilibrium quantity that will be produced and sold in the market. \end{itemize} All individual firms in the industry must accept this price P* and will then decide their own profit-maximizing output level based on this price.

Step 4: Final Answer:
Under perfect competition, the price and quantity of a commodity are determined at the industry level by the interaction of market demand and market supply. The equilibrium is established at the point where the demand and supply curves intersect.