CHAPTER 7
THEORY OF FIRMS AND MARKET STRUCTURE I : PERFECT COMPETITION AND MONOPOLY
PREPARED BY : SITI NORDIYANA ISAHAK

THEORY OF FIRM
• FIRM – an organization/ institution that combines all resources for the production of goods and services. • INDUSTRY – a group of firm that produces or sells similar product in the same market. E.g : manufacturing industry such as textile, soaps, foods, servicing industry and so on. • Firm’s objective – maximize profit – attain production efficiency whereby cost is minimized TOTAL PROFIT = TR – TC if TR >TC → Profit (+ve) if TR <TC → Loss (-ve)

EQUILIBRIUM OF A FIRM
• Equilibrium of a firm implies the desirable level to attain under given condition. • A firm is in equilibrium when it earns maximum profit or minimum losses. • Assumption:
– Rational firm – Production of one product – Least cost combination

• Two approaches to maximize profit: i. Aggregate Approach (Total Approach) ii. Marginal Approach

AGGREGATE APPROACH /TOTAL APPROACH
• Profit is maximize when the difference between TR and TC is the largest. • Total Profit = TR –TC.
Firm’s equilibrium in Perfect competition

Quantity 1 2 3 4 5 6 7 8

Price 10 10 10 10 10 10 10 10

TR 10 20 30 40 50 60 70 80

TC 15 20 28 35 46 58 70 82

Profit -5 0 2 5 4 2 0 -2

Cont’d: Types of Profit
1. Supernormal or Economic Profit TR > TC 2. Normal Profit or Breakeven Point TR = TC 3. Subnormal or Losses TR < TC

Price/cost

TC TR

LOSS
TR: 40 TC: 35

PROFIT(TR-TC) LOSS OUTPUT

2

4

7

CONCLUSION : the vertical difference between the TR and TC

curves gives profit at each level of production. At lower levels of output, the firm will incur a loss. As production increases, profits increase and eventually reaching a maximum level at output 5. If the firm were to produce more than 5, profits would decline.

MARGINAL APPROACH equilibrium output is when the MR of producing an additional