Total revenue represents all the company income. Total revenue is calculated by multiplying the price of products with the quantity sold. Typically, total revenue is calculated as follows:
Total revenue = price x quantity
Where price (P) and quantity (Q).
As being revealed in Table 1, total revenue is calculated by multiplying price with quantity, when firm produces 2 quantities of goods, firm’s total revenue is $10, however, when a firm produces 3 quantities of goods, its total revenue is $15.
Marginal revenue is an additional revenue that a firm generates when a firm sells additional unit of output. The marginal revenue plays an important role in the perfectly competitive firm where a perfectly competitive firm maximizes its profit when marginal revenue is equal to marginal cost. The formula used to calculate marginal revenue is:
Marginal revenue= Change in total revenue/Change quantity.
The average revenue is calculated by dividing the total revenue by the quantity produced.
The table below summarizes a firm’s marginal revenue:
Table 1: Total Revenue and Marginal Revenue of a Perfect Competitive Firm ($)
Within the perfect competitive market structure, perfect competitive firms are price takers because they have no control of the market and they receive the market price offered to them in the market. In the market competition, there are many firms selling identical products and each firm charges the same market price for the goods sold because a firm has to charge the market price to remain in business. Charging above the market price will make firms to lose its customers and charging below the market price will makes firms to lose profits.
Under perfect competition, the price is constant making firms to earn the same marginal revenue no matter the quantity of the goods sold. As being revealed in Table 1, the price is $5 no matter the quantity sold and increase in the quantity produced will not change the price. Under perfect competition, the total revenue is the quantity produced multiplied by the price and the marginal revenue is constant which is equal to the price.
1b. Fig 1: Total Revenue, Marginal Revenue and Average Revenue of Price Taker firm
Fig 2: Marginal Revenue, Average Revenue and Total revenue of Price fixing Firm
There are fundamental difference between price taker and price fixing firm. Overview the fig 1 reveals that marginal revenue and average revenue are the same and they are equal to price under the perfect competition. On the other hand, the average revenue (AR) and marginal revenue (MR) is downward slope under price fixing firm (See Fig 2). Typically, the price under monopoly (price fixing firm) faces downward slopping market demand curve. While the price of price taker remains constant, the price fixers sell additional units by lowering the price. While the marginal revenue of price taker remains the same with increase in production, the marginal revenue of price fixers declines with increase in the quantity offered to the market.
Moreover, the price is equal to marginal revenue (P=MR) under the price taker, however, the price setter take into account the production level before it sets the price. Thus, marginal revenue is not equal to price under the price setter.
1c. Price elasticity of demand measures the degree of responsiveness of demand as a result of change in price. The formula used to calculate the price elasticity of demand is as follows:
Price elasticity of demand= % Change in Quantity Demand/% Change in Price
Fig 3: Demand curves under elastic and inelastic demand
Elasticity of demand and total revenue for a producer / supplier
Under elastic demand, demand curve is vertical in slope while the demand curve for inelastic demand is downward slope. Typically, under elastic demand curve, a 20% change in price will lead to more than 20% change in demand. However, under inelastic demand, a 20% change in price will make the demand by less than 20% in demand.
2a. Marginal costs are the additional costs needed to produce additional products. On the other hand, average costs are the total costs divided by the total quantity of goods. Marginal cost curve cuts the average costs curve at the lowest point because if the average costs are falling, the costs of producing extra unit of output will be falling. As being illustrated in fig 4, if the average cost is falling the marginal costs will be less than the average costs. Thus, the average costs curve will be above the marginal cost when the average cost is falling. On the other hand, average costs curve will be below marginal costs curve when average cost is rising. Thus, average costs and marginal costs will be at the same level when average cost is constant. If the average costs curve is U. shaped, this mean that marginal costs will cut the average costs at the minimum point. (See Fig 4).(Sloman, and Sutcliffe, 2004).
Figure 4: MC curve cuts the AC curve at its minimum point.
To calculate the total cost, marginal costs and average cost of producing 20 units of output?
First, we need to calculate the labor costs.
A unit of output = 4 hours of labor
Hours wage =Â£5-HOUR
Thus, the costs of labor are= 4×5= Â£20
Next, we need to calculate the capital
Capital is rented at a fee of Â£15 per hour
Thus, costs of 2 hours used for capital is 15×2=Â£30
Fixed costs for all goods produced =Â£100
Thus, total cost of producing one unit of output is as follows:
Fixed Cost =Â£100
Total costs to produce one unit of output =20+30=150
Since the fixed costs is constant no matter the level of production, the total costs of producing 20 units of output (50×20)+100=Â£1100
Average costs =Total Cost/Total Output
Average costs =1100/20
Average costs =Â£55
Table: Total Costs, Marginal Costs and Average Costs of Producing 20 units of Output (Â£)
The costs structure is typically example of perfect competition because the marginal cost is constant no matter the level of production. (Aderton, 1977).
2C . The process in the exhibit b is the example of economic of scale because the average cost declines as there is an increase in the total output making the firm to enjoy a decline in the operation costs. However, if the firm sells its output at Â£55 per unit, the optimal scale of operation is when the firm produces 21 units because this is the quantity where MC cuts the AC from below.
When firm produces 21 units at Â£55 the total costs will be 21×55 =Â£1155. At this point of production marginal costs will be Â£55 while the average costs will be 1155/21=Â£55.
In the contemporary business environment, firms coordinate production and distribution of goods and services. To lower the costs, firms often enter into the contract with the third party agents to implement the distribution or production of their goods on their behalf. To enter into the business with the third party vendor, firm needs to enter into market contact with the third party agents. However, the transaction costs of entering contract with the third party agent could be high if the moral hazard or information asymmetry is involved and the cost of asset specificity is too high. This issue could make the market contact to be high.
3b. Diminishing marginal utility occurs when there is a less incremental satisfaction by consuming the incremental unit of the same goods. Adverse selection is a situation of asymmetric information where high quality consumers are squeezed out from transaction. In the insurance company, those in need of the insurance will be attracted to the premium. However, premium will rise as unhealthy people are interested in the insurance, which will lead to the decline of marginal utility of insurance for the sick people.
3c. In a free market price mechanism, there could be a shortage in the market when the supply are less than the demand. To resolve the shortage in the market, there is a need to increase the price of goods to encourage producer to produce more goods thereby supply more product into the market. By supplying more goods into the market, the shortage will be eliminated and the equilibrium price and quantity will stabilize. On the other hand, lowering the price will resolve surplus in the market because suppliers will be discouraged to supply large quantity of goods into the market.
3d. The performances of firm is largely influenced by the organizational structure because organizational structure largely affects innovation and organizational learning which eventually enhance organizational performances. Organizations that encourage learning and innovation will be able to provide value for customer, which will assist organizations to achieve competitive market advantages.
List of References
Aderton, (1977).Economics. Pearson Education
Sloman, A and Sutcliffe, M (2004). Economics for Business. Prentice Hall.
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