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Karnataka Class 12 Commerce Economics Chapter 5 Theory Of The Firm And Perfect Competition Notes

Karnataka Class 12 Commerce Economics Chapter 5 Theory Of The Firm And Perfect Competition Notes

Karnataka Class 12 Commerce Economics Chapter 5 Theory Of The Firm And Perfect Competition : Karnatak University is a state university located in the city of Dharwad in the state of Karnataka in India. It was established in October 1949, and officially inaugurated in March 1950. The campus spans 750 acres (3 km²). D. C. Pavate was the first official vice-chancellor from 1954 to 1967. The rapid development of the institution is credited to him.

The university was recognized with the “Potential for Excellence” by the University Grants Commission. The university is the second oldest university in the state of Karnataka after the University of Mysore. The Karnatak university once used to serve most of the Karnataka region including Dharwad, Belagavi, Uttara Kannada, Bijapur, Gulbarga, Raichur, Bidar and Bellary. until the 1980s (Manipal Institute of Technology and the Kasturba Medical College of Manipal were affiliated with Karnatak University at Dharwad and all degrees were awarded by Karnatak University in between the years from 1953 to 1965)

Karnataka Class 12 Commerce Economics Chapter 5 Theory Of The Firm And Perfect Competition Notes

Karnataka Class 12 Commerce Economics Chapter 5 Theory Of Th Firm And Perfect Competition :  In the previous chapter, we studied concepts related to a firm’s production function and cost curves. The focus of this chapter is different. Here we ask : how does a firm decide how much to produce? Our answer to this question is by no means simple or uncontroversial. We base our answer on a critical, if somewhat unreasonable, assumption about firm behaviour – a firm, we maintain, is a ruthless profit maximiser. So, the amount that a firm produces and sells in the market is that which maximises its profit

The structure of this chapter is as follows. We first set up and examine in detail the profit maximisation problem of a firm. This done, we derive a firm’s supply curve. The supply curve shows the levels of output that a firm chooses to produce for different values of the market price. Finally, we study how to aggregate the supply curves of individual firms and obtain the market supply curve.

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Karnataka Class 12 Commerce Economics Chapter 5 Theory Of The Firm And Perfect Competition Notes

Karnataka Class 12 Commerce Economics Chapter 5 Theory Of The Firm And Perfect Competition : In order to analyse a firm’s profit maximisation problem, we must first specify the market environment in which the firm functions. In this chapter, we study a market environment called perfect competition. A perfectly competitive market has two defining features.

1. The market consists of buyers and sellers (that is, firms). All firms in the market produce a certain homogeneous (that is, undifferentiated) good.

2. Each buyer and seller in the market is a price-taker. Since the first feature of a perfectly competitive market is easy to understand, we focus on the second feature.

From the viewpoint of a firm, what does price-taking entail? A price-taking firm believes that should it set a price above the market price, it will be unable to sell any quantity of the good that it produces. On the other hand, should the set price be less than or equal to the market price, the firm can sell as many units of the good as it wants to sell. From the viewpoint of a buyer, what does pricetaking entail? A buyer would obviously like to buy the good at the lowest possible price. However, a price-taking buyer believes that should she ask for a price below the market price, no firm will be willing to sell to her. On the other hand, should the price asked be greater than or equal to the market price, the buyer can obtain as many units of the good as she desires to buy. Since this chapter deals exclusively with firms, we probe no further into buyer behaviour. Instead, we identify conditions under which price-taking is a reasonable assumption for firms.

Karnataka Class 12 Commerce Economics Chapter 5 Theory Of The Firm And Perfect Competition : Price-taking is often thought to be a reasonable assumption when the market has many firms and buyers have perfect information about the price prevailing in the market. Why? Let us start with a situation wherein each firm in the market charges the same (market) price and sells some amount of the good. Suppose, now, that a certain firm raises its price above the market price. Observe that since all firms produce the same good and all buyers are aware of the market price, the firm in question loses all its buyers. Furthermore, as these buyers switch their purchases to other firms, no “adjustment” problems arise; their demands are readily accommodated when there are many firms in the market. Recall, now, that an individual firm’s inability to sell any amount of the good at a price exceeding the market price is precisely what the price-taking assumption stipulates.

REVENUE

Karnataka Class 12 Commerce Economics Chapter 5 Theory Of The Firm And Perfect Competition : We have indicated that in a perfectly competitive market, a firm believes that it can sell as many units of the good as it wants by setting a price less than or equal to the market price. But, if this is the case, surely there is no reason to set a price lower than the market price. In other words, should the firm desire to sell some amount of the good, the price that it sets is exactly equal to the market price. A firm earns revenue by selling the good that it produces in the market. Let the market price of a unit of the good be p. Let q be the quantity of the good produced, and therefore sold, by the firm at price p. Then, total revenue (TR) of the firm is defined as the market price of the good (p) multiplied by the firm’s output (q). Hence,

To make matters concrete, consider the following numerical example. Let the market for candles be perfectly competitive and let the market price of a box of candles be Rs 10. For a candle manufacturer, Table 4.1 shows how total revenue is related to output. Notice that when no box is produced, TR is equal to zero; if one box of candles is produced, TR is equal to 1 × Rs 10 = Rs 10; if two boxes of candles are produced, TR is equal to 2 × Rs 10 = Rs 20; and so on.

Karnataka Class 12 Commerce Economics Chapter 5 Theory Of The Firm And Perfect Competition : With the example done, let us return to a more general setting. In a perfectly competitive market, a firm views the market price, p, as given. With the market price fixed at p, the total revenue curve of a firm shows the relationship between its total revenue (y-axis) and its output (x-axis). Figure 4.1 shows the total revenue curve of a firm. Three observations are relevant here. First, when the output is zero, the total revenue of the firm is also zero. Therefore, the TR curve passes through point O. Second, the total revenue increases as the output goes up. Moreover, the equation ‘TR = p × q’ is that of a straight line. This means that the TR curve is an upward rising straight line. Third, consider the slope of this straight line. When the output is one unit (horizontal distance Oq1 in Figure 4.1), the total revenue (vertical height Aq1 in Figure 4.1) is p × 1 = p. Therefore, the slope of the straight line is Aq1 /Oq1 = p.

Now consider Figure 4.2. Here, we plot the market price (y-axis) for different values of a firm’s output (x-axis). Since the market price is fixed at p, we obtain a horizontal straight line that cuts the y-axis at a height equal to p. This horizontal straight line is called the price line. The price line also depicts the demand curve facing a firm. Observe that Figure 4.2 shows that the market price, p, is independent of a firm’s output. This means that a firm can sell as many units of the good as it wants to sell at price p.

The average revenue ( AR ) of a firm is defined as total revenue per unit of output. Recall that if a firm’s output is q and the market price is p, then TR equals p × q. Hence AR = TR q = p q q × = p

The marginal revenue (MR) of a firm is defined as the increase in total revenue for a unit increase in the firm’s output. Consider a situation where the firm’s output is increased from q 0 to (q 0 + 1). Given market price p, notice that

MR = (TR from output (q 0 + 1)) – (TR from output q 0 )

= (p × (q 0 + 1)) – (pq 0 ) = p

In other words, for a price-taking firm, marginal revenue equals the market price. Setting the algebra aside, the intuition for this result is quite simple. When a firm increases its output by one unit, this extra unit is sold at the market price. Hence, the firm’s increase in total revenue from the one-unit output expansion – that is, MR – is precisely the market price.

Karnataka Class 12 Commerce Economics Chapter 5 Theory Of The Firm And Perfect Competition Notes

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