Introduction to Economics 1 Revenue and profit 2

Introduction to Economics

1. Revenue and profit 2. Perfect competition 3. Imperfect competition 3/6/2021 2

Rational producer ─ Producer aims at achieving an efficient level of production with given inputs (and sales) in order to maximize his profit. ─ Further examples of firms’ objectives: ─ Market share ─ Survive in the long run ─ Good reputation for management ─ Stakeholder interests ─ However, profit is an important factor of firm’s competitiveness 3/6/2021 3

Revenue ─ Total revenue (TR) – income that a company receives from the sale of goods and services. TR = P*Q ─ Average revenue (AR) – income per unit of product. ─ Marginal revenue (MR) – is the extra income generated by selling one more unit of production. AR = TR / Q 3/6/2021 MR = TR / Q 4

Profit ─ Profit is the difference between revenue and the costs of bringing products to market: Z = TR - TC ─ Accounting profit = TR – explicit costs ─ Economic profit = accounting profit – implicit costs ─ If the economic profit is equal to zero, the firm is still getting the so-called “normal profit” which is the minimum required by entrepreneur to stay in business and not to think of changing the job. 3/6/2021 5

1. Revenue and profit 2. Perfect competition 3. Imperfect competition 3/6/2021 6

What is competition? ─ Competition is a situation in which two or more people or groups are trying to get something which not everyone can have. ─ Competition is an activity involving two or more firms, in which each firm tries to get people to buy its own goods in preference to the other firms' goods. ─ Competition appears when there is two or more subjects whose interests (needs) are in rivalry (i. e. not everyone is allowed to reach the objects of their interests). 3/6/2021 7

Where can we find competition? ─ Competition on the demand side ─ Competition on the supply side ─ Competition between demand supply Is competition good or bad? ─ It depends on the point of view…. What should competition look like? 3/6/2021 8

Ideal market model: 5 traits (attributes) of perfect competition (1) ─ Numerous small producers and consumers: none of them is capable of influencing the price. ─ If any of them increases the price, consumers will easily switch to the substitute. ─ Homogenic product: product parameters are alike. = The agriculture market is very close to perfect competition. However, it is not totally the same… 3/6/2021 9

Ideal market model: 5 traits of perfect competition (2) ─ No entrance or exit barriers: neither producers nor consumers have problems with entering or leaving the market. If the firm stops generating profit, the entrepreneur would easily leave. ─ Independent market agents: neither firms nor customers can agree on common behavior strategy and therefore influence the price. ─ Perfect information: firms and consumers have a perfect overview of prices and other market conditions and therefore act rationally. 3/6/2021 10

Ideal market model: perfect competition ─ In perfect competition conditions the invisible hand of market does work; source allocation is efficient and the economy is on its production possibility frontier. ─ Price is independent from the firm’s actions: the firm is capable of selling all its stock without influencing the price; demand is perfectly elastic. 3/6/2021 11

Perfect competition: Price takers ─ Market supply and demand determine the price; single firms are too small to influence prices. ─ The demand curve of the firm is perfectly elastic. P D S P The firms are price takers D P = AR = MR In perfect competition the price, average revenue and marginal revenue are constant. Q Industry 3/6/2021 Q Single firm 12

Perfect competition: profit maximizing ─ Since the price is exogenous, producers should determine the optimal production volume based on interaction between costs and price. P, AC, MC MC TR = P*Q TC = AC*Q Z = TR - TC Rule: In perfect competition the firm would maximize its profit by producing such quantity when MC are equal to price. AC P Max Z: MC = MR=P 1 3/6/2021 2 3 4 5 6 Q 13

If the revenues gained from selling additional unit of production are higher than the costs paid for producing this additional unit (i. e. MR > MC), then increasing the production leads to higher profit => Produce more! Profit maximizing P i Relative loss 10 8 6, 5 6 MC AC Absolute loss 13 12 P(= AR = MR) If the revenues gained from selling additional unit of production are lower than the costs paid for producing this additional unit (i. e. MR < MC), then increasing the production leads to lower profit => Produce less! LOSS Profit 3 500 Q 1 Q 2 Q 3 Q 4 Q 5 800 1000 1200 1600 Q i

Perfect competition: when should the firm stop its activities in the short run?

Další informace dole v poznámce Lowest price in Shut down point in SR long run (MC = AC) and LR Shutdown point in long run P=AC MC = S P i P 1 = 45 AC AVC P = AR = MR Profit P 2 = 30 P 3 = 20 P 4 = 10 Profit is (P = AC) Shutdown in maximized at price long run (P = AVC) Shutdown in P 1 and production short run volume Q 1 (P < AVC) Firm leaves the (MR = MC) Shutdown point in market short run P = AVC Loss = FC + Loss = FC Loss + VC Q Q 3 Q 2 4 Lowest price in 4 000 10 000 7 000 short run (MC = AVC) Q 1 13 000 Q i

1. Revenue and profit 2. Perfect competition 3. Imperfect competition 3/6/2021 19

Imperfect competition: ─ Imperfect competition exists there, where sellers have certain control over the price of their output (market power). ─ This, however, doesn’t necessarily mean that the control is absolute: its extent depends on the type of imperfect competition. ─ Main types of imperfect competition: ─ monopoly, ─ oligopoly, and ─ monopolistic competition. 3/6/2021 20

Monopoly: opposing perfect competition ─ It is an extreme case: one seller with the total control over industry branch. ─ Pure monopolies are rare today, before all, due to antimonopoly laws. Reasons for their existence: ─ Legal barriers (patents, licences - Microsoft), protectionist policy, high entrance barriers (ČEZ), geographic location. ─ Natural monopoly ─ Is the case when the only one big firm with the lowest AC is capable of satisfying market demand instead of many smaller firms. Exists in branches with wide returns to scale possibilities. 3/6/2021 21

Oligopoly ─ Several (2, 5 or even 15) firms on the market given each can influence the market price. ─ Some economists assume that oligopoly is the situation when 4 biggest firms have over 40 percent market share. ─ Returns to scale are lower than monopoly has. ─ Firms compete with each other: ─ Price wars: if one reduces the price, others have to react. ─ Threat of cartel agreements. 3/6/2021 23

Monopolistic competetion ─ A lot of firms satisfying demand together. ─ Each of them has a small market share. ─ Product is differentiated, each producer tends to create and hold its own segment. ─ Importance of non-price competition: ads, marketing, customer services, etc. … 3/6/2021 24

Imperfect competition: Common traits (1) ─ Differentiated product: ─ One product differs from competitive ones. ─ Significant market shares of firms: ─ The firm can influence price and quantity supplied. ─ Entrance and exit barriers: ─ ─ 3/6/2021 Legal restrictions Customer loyalty Ads – not all products can be sold Existing returns to scale and diminishing costs 25

Imperfect competition: Common traits(2) ─ Unfair competition: firms can agree on the common strategy – cartel agreements ─ Insufficient information ─ Neither firms, nor consumers have the complete overview of prices and market conditions; uncertainty exists. 3/6/2021 26

Imperfect competition: profit maximizing ─ Producers can influence price: e. g. by limiting production they increase the price. The price change therefore influences the revenues depending on elasticity. TR = P*Q ─ The firm is maximizing its profit by producing the amount of goods that corresponds to equality of marginal revenue and marginal costs. Max Z: MC = MR 3/6/2021 !!! MC = MR < P 27

TR, AR and MR in percect and imperfect competition € P € TR TR AR = P = MR = d Q AR = P MR Q

Optimal production volume of a monopolist ─ Firms in imperfect competition get monopolist profits; it may last much longer than in perfect competition conditions due to entrance barriers. P, C D=AR MR MC AC P Profit ? ? ? E 1 3/6/2021 2 3 4 5 6 Q TR = P*Q TC = AC*Q Z = TR - TC Max Z: MC = MR Rule: In order to maximize profits the monopolist sets production on the level where MC=MR. This output level is lower compared to what could have been under perfect competition conditions. 29

Production volume optimization differences between perfect and imperfect competition P, C MC D=AR MR MC AC P = AC Profit = P D=AR =MR=P E E 1 3/6/2021 2 3 4 5 6 Q 30

Conclusion Type No of firms Product Market power Entrance barriers Perfect competition many homogenous none low Monopolistic competition many differentiated limited low Oligopoly few differentiated medium high very high Monopoly 3/6/2021 one Homogenous without close substitutes 33

Thank you for attention! Refernces: SAMUELSON, P. A. , NORDHAUS, W. D. Ekonomie 18. vydání. Praha: Svoboda, 2005. KRAFT, J. , RITSCHELOVÁ, I. Ekonomie pro environmentální management. Ústí n. L. : UJEP, 2003. MCDOUGAL LITTELL. Economics: Concept and Choices. Canada: Mc. Dougal Littell, 2008. www. intel. com