Marginal revenue and Marginal cost approach

The second method of showing equilibrium of the firm is in terms of marginal revenue and marginal cost curves.

There are three condition that must be satisfied for the profits to be maximum.

Rule 1 :

In the short run, a firm should produce 

if and only if P or AR > AVC  OR TR > TVC

1) A firm has to incur fixed cost even if there is no production, firm sometimes continues to produce even when it is facing losses.

If a firm decides to shut down and produce nothing, the losses would be equal to its fixed cost.

2) A profit earning firm will never lose more than its fixed cost, if the revenue is so low that the firm is unable cover its variable cost, to avoid this cost a firm can stop (cease) production, but if the firm still has the capital to resume production later, 

so this is a situation of Shut down ( a firm produce no output to minimise its lose).

Behaviour of Revenue Monopoly

A firm under monopoly is required to reduce the price if it wants to sell more.

A monopolist by definition is price taker.

Being a single seller of the product in the market, he can fix whatever price he wishes to.

But he can sell more only if he lowers the price of his product.

Thus, there is a negative relationship between price of the product and demand for the product in a monopoly market.

Thus firms demand curve or AR curve (price line) slopes downwards.

Tabular Relationship between TR, AR and MR under Monopoly

Units of output (Q)	Price / AR  ( P)	TR	MR (TRn- TRn-1)
1 2 3 4 5 6 7	20 18 16 14 12 10 8	20 36 48 56 60 60 56	20 16 12 8 4 0 -4

Behaviour of Revenue

We distinguish between two types of market situation in this situation

1) Perfectly competitive market

2) Imperfectly competitive market

The behaviour of Toal revenue, Average revenue and Marginal revenue will be different in the two types of market.

Relationship between TR, AR and MR under Perfect Competition

A firm under perfect competition is able to sell additional units of output at the ruling price. It is not required to reduce the price to sell more.

Reason:

As perfect competition is a market structure where there are large number of firms, so increase or decrease in production by any one firm do not affect in total supply in the whole market and also on price.

The collective force of demand and supply determines price in perfect competition which prevails in the market.

So each firm sells at the prevailing price (so do not reduce the price to sell more).

So firms are price taker and their demand curve is perfectly elastic.

Tabular Relationship between TR, AR and MR under Perfect Competition

Units of output (Q)	Price  ( P)	AR (TR / Q)		TR (P x Q)	MR (TRn- TRn-1)
1 2 3 4 5	10 10 10 10 10	10 10 10 10 10	10 20 30 40 50		10 – 0 = 10 20 – 10 = 10 30 – 20 = 10 40 – 30 = 10 50 – 40 = 10