Chapter 7: Product Pricing Theories and Practices

Numerical Examples:
Example 1:
Calculate the total profit of the firm when P = Rs.10, Q = 15 units and AC = Rs.5.

Solution:
Given
P = Rs.10, Q = 15 units, AC = Rs.5
We know that TR = P x Q =10 x 15 = Rs.150
TC = AC x Q = 5 x 15 = Rs.75
Total Profit π = TR – TC
i.e. = Rs.150 - Rs.75 = Rs.75
Hence total profit π = Rs.75

Example 2:
Derive MR and MC functions from the TR and TC functions given below.
TR = 10 - 4Q2
TC = 50 + 6Q2

Solution:
Given TR = 10 - 4Q2, and TC = 50 + 6Q2
2
d (TR) d(10−4 Q )
We know MR = = = - 8Q
Q dQ
2
d (TC) d (50+6 Q )
and MC = = = 12Q
Q dQ
∴ MR = -8Q, and MC = 12Q

Example 3:
Calculate equilibrium level of output of the firm when marginal revenue is MR = 300 - 0.5Q
and marginal cost (MC) = 50 + 2Q.

Solution
Given MR = 300 - 0.5Q, and MC = 50 + 2Q

For equilibrium level of output, MR = MC

i.e. 300 - 0.5Q = 50 + 2Q
i.e. - 0.5 - 2Q = 50 - 300
i.e. -2.5Q = - 250
250
∴Q= = 100 units
2.5

Hence equilibrium level of output (Q) = 100 units

Example 4:
Find the equilibrium level of output of a firm if MR = 40 and MC = 40 - 30Q + 3Q2.

Solution
Given MR = 40, and MC = 40 - 30Q + 3Q2
For equilibrium MR = MC
i.e. 40 = 40 - 30Q + 3Q2
i.e. 3Q2 - 30Q = 40 – 40
i.e. 3Q2 - 30Q = 0
i.e. Q(3Q -30) = 0
∴ Either, Q = 0 or, 3Q - 30 = 0
∴Q = 10

The equilibrium level of output cannot be zero (Q ≠ 0) and therefore, Q = 10 units

Example 5: At the point of equilibrium under monopoly, coefficient of price elasticity of

demand and marginal cost are 2 and Rs.20, respectively. Compute monopoly price.

Solution:
Since, at equilibrium, MC = MR
∴ MR = Rs.20

Again, P = MR ( e−1e )
i.e. P = 20 (
2−1 )
2
= Rs.40

Example 6:
Calculate the equilibrium level of output of the firm when marginal revenue is MR = 300 –
0.002Q and marginal cost is MC = 20 + 0.0008Q.

Solution:
Here, MR = 300 – 0.002Q and MC = 20 + 0.0008Q.
For equilibrium MR = MC
i.e. 300 – 0.002Q = 20 + 0.0008Q
i.e. 300 – 20 = 0.0008Q + 0.002Q
i.e. 280 = 0.0028Q
280
∴Q= =¿10000
0.0028
∴Equilibrium level of output of the firm = 10000 units.

Example 7:
Suppose a monopoly firm facing a demand curve with negative slope has its price fixed at
Rs.100 where e = 1. Compute marginal revenue.

Solution:
We know that MR = AR ( e−1e ). Here, P = AR = Rs.100, and e = 1. Substituting these values
in MR = AR ( ) , we will have MR = 100 (
1 )
e−1 1−1
= 0. Therefore, MR = 0.
e

Example 8:
Suppose a simple monopolist is in equilibrium. At the point of equilibrium, the coefficient of
price elasticity is 2 and marginal cost is Rs.4. Calculate monopoly's equilibrium price.
Solution:
As we know, monopolist will be in equilibrium, when profit maximising price P = MC

( )
e
e+ 1
. Here, MC = Rs.4, and e = 2.

Substituting these values in P = MR ( )e

e+ 1
, we will have

P=4 ( )
−2
−2+1
= =4 ( )
−2
−1
= =4
2
1 ()
= 8.
Therefore, equilibrium price = Rs.8

Example 9:
Suppose price charged by a monopolist at equilibrium is twice as high as its MC. What is the
price elasticity of demand?

Solution:
In price-output equilibrium of a monopolist MR = MC.

( ) 1
Since MR = P 1− , in equilibrium, MC = P 1− .
e ( )
1
e
Suppose that elasticity of demand e = 2,

( )1
Substituting the value of e in MC = P 1− , we will have
e

( ) 1 1
MC = P 1− = P , i.e. P = 2MC.
2 2
Hence it is proved that price charged by a monopolist at equilibrium will be twice as high as
its MC.

[For clarification: MR = P ( e−1e ). Since at equilibrium, MR = MC, therefore P ( e−1e ) =

MC i.e. P = MC ( e−1e ). Thus, this equation provides a rule of thumb for pricing by a
monopolist.
Therefore, if a monopolist knows marginal cost of his product, and the value of price
elasticity of demand, he can easily calculate what price he should fix to maximise his profit.]

Example 10:
A firm's total revenue is Rs 10000, its total cost is Rs 12000, and its total fixed cost is Rs
4000. Should the firm stay in business? Why?

Solution:
Given TR = 10000, TC = 12000, TFC = 4000.
Profit = TR – TC = 10000 – 12000 = -2000
Therefore, this firm is incurring a loss of Rs.2000.

As we know, variable cost increases with the increase in output. The decision to stay in
business depends on the AVC and the price of the product.
Since this firm is incurring a loss of Rs.200, the decision to stay in business or quit depends
on the AVC and the price of the product.
As we know, TC = TFC + TVC
Therefore, TVC = TC – TFC.
i.e. TVC = 12000 – 4000 = 8000.

In order to arrive at the decision on whether to continue production or shut down, we need to
see if the P > AVC. If P < AVC, then the firm should shut down its production, and if P >
AVC, then it can continue the production, irrespective of the loss, since it can at least cover
the variable cost, and leave a contribution margin to cover at least part of the fixed costs, in
the short run. If P = AVC, the firm would be indifferent between closing down or continuing
to produce.
TVC TC TR
As we know, AVC = , AC = , and AR or P =
Q Q Q
As we know, variable cost increases with the increase in output. Since the common
denominator is Q, the trend in TC depends on the trend in TVC.

Here, TR = 10000, and TVC = 8000. Since the revenue (10000) > TVC (8000), it implies that
this firm covers the variable cost, and leaves Rs.2000 as a contribution margin to cover the
Fixed Cost. Therefore, this firm can stay in business, despite incurring loss of Rs.2000, in the
short run.

Example 11:
A firm’s TR = Rs.2000, its TC = Rs.2200, and its TFC = Rs.1000. Should the firm stay in
business? Why?

Solution:
Given TR = 2000, TC = 2200, TFC = 1000.
Profit = TR – TC = 2000 – 2200 = -200
Therefore, this firm is incurring a loss of Rs.200.

Since this firm is incurring a loss of Rs.200, the decision to stay in business or quit depends
on the AVC and the price of the product.
As we know, TC = TFC + TVC
Therefore, TVC = TC – TFC.
i.e. TVC = 2200 – 1000 = 1200.
Thus, TVC = Rs.1200.
In order to arrive at the decision on whether to continue production or shut down, we need to
see if the P > AVC. If P < AVC, then the firm should shut down its production, and if P >
AVC, then it can continue the production, irrespective of the loss, since it can at least cover
the variable cost, and leave a contribution margin to cover at least part of the fixed costs, in
the short run. If P = AVC, the firm would be indifferent between closing down or continuing
to produce.
TVC TC TR
As we know, AVC = , AC = , and AR or P =
Q Q Q
As we know, variable cost increases with the increase in output. Since the common
denominator is Q, the trend in TC depends on the trend in TVC.

Here, TR = 2000, and TVC = 1200. Since the revenue (2000) > TVC (1200), it implies that
this firm covers the variable cost, and leaves Rs.800 as a contribution margin to cover the
Fixed Cost. Therefore, this firm can stay in business, despite incurring loss of Rs.200, in the
short run.

Example 12:
From the following Table, find out equilibrium price and write down why is it equilibrium
price.
Price Demand Supply
50 5 25
40 10 20
30 15 15
20 20 10
10 25 5
Solution:
As we know, the condition for the equilibrium of industry is Market demand = Market
supply.
In the given Table, we find that when Price = Rs.30, Market demand (15) = Market supply
(15). Hence we conclude that Rs.30 is the equilibrium price.

Example 13:
What level of profit will be obtained by a competitive firm at the condition of MR = Rs.200,
and AC = Rs.200, in the long run.

Solution:
Given MR = Rs.200, and AC = Rs.200
As we know, for a competitive firm AR = MR = Price.
Therefore, since MR = Rs.200, AR = Rs.200, and Price = Rs.200
We also know that AC = Rs.200.
Therefore, this firm’s AC (200) = AR (200) = MR(200), P(200).
It implies that the minimum point of AC curve is tangent or touches the MR curve at the
point of equilibrium.
We know that MC curve intersects the AC at the minimum point of AC. Thus, it is clear that
AC (200) = AR (200) = MR(200) = P(200) = MC(200).

∴ Profit, π = TR – TC
TR = AR x Q, and TC = AC x Q.
Since AR(200) = AC(200),
Therefore, irrespective of the level of output, Q, TR = TC
∴ Profit, π = TR – TC = 0
i .e . Profit, π = 0
Hence we conclude that this firm in the long run earns normal profit.

Example 14:
Calculate the profit of the firm, when P = Rs.30, Q = 10 units, and AC = Rs.25

Solution:
Given P = Rs.30, Q = 10 units, and AC = Rs.25
We know that Profit, π = TR – TC
We also know that P= AR
∴ TR = AR x Q = 30 x 10 = Rs.300
 and TC = AC x Q = 25 x 10 = Rs.250
Since π = TR – TC
i.e. = 300 – 250 = 50
Thus, Profit, π = Rs.50

Example 15:
Fill in the following Table:
Output (Q) Price (P) TR TC Profit
1 10 5
2 9 12
3 8 18
4 7 22
5 6 30
Solution:
We know that TR = P x Q, and Profit, π = TR – TC.
Thus, we have the filled-in Table as shown here.
Output (Q) Price (P) TR TC Profit
1 10 10 5 5
2 9 18 12 6
3 8 24 20 4
4 7 28 28 0
5 6 30 35 -5

Example 16:
A firm’s TR = Rs.2000, its TC = Rs.2200, and its TFC = Rs.1000. Should the firm stay in
business? Why?

Solution:
Given TR = Rs. 2000, TC = 2200, and TFC = Rs.1000

We know that π = TR – TC = 2000 – 2200 = -200.

Since TC > TR, this firm is making a loss of Rs.200 in the short run.

We know that TVC = TC – TFC = 2200 – 1000 = 1200

Thus, TVC = Rs.1200.

A firm has to analyze two possibilities while making decision about shutting down of a firm
incurring loss in the short run:

(i) The firm gets price (average revenue) less than average total cost (AC), but greater than
average variable cost (AVC < P < AC).

(ii) The firm gets price (average revenue) even less than average variable cost (P < AVC).

Therefore, even though this firm is incurring a loss of Rs.200, depending on number of units
sold by this firm, if its P i.e. AR < AC, it can continue its production till its P = AVC, since it
can at least cover its variable cost per unit. However, if the P i.e. AR is less than AC, and also
less than its AVC, then this firm should shut down. The point at which P = AVC is known as
shut down point.

Example 17:
The cost function of a perfectly competitive firm is TC= 5 + 4Q + Q 2 and market price is
Rs.8. Find out the profit maximizing level of output.

Solution
Given Market price P = Rs.8
TC = 5 + 4Q + Q2
2
d (TC) d (5+ 4 Q+Q )
MC = = = 4 + 2Q
Q dQ

In the perfectly competitive market, MR = AR = P = Rs. 8

∴MR = Rs.8

For equilibrium: MC = MR
i.e. 4 + 2Q = 8
i.e. 2Q = 8 - 4
i.e. 2Q = 4 .
4
∴Q= =2
2
This, profit maximizing level of output is 2 units.

Example 18:
The following table shows the average cost and average revenue (price) for a firm at each
level of output.
Q 1 2 3 4 5 6 7 8 9 10
AC 7 5 4 3.25 3 3.1 3.5 4.2 5 6
AR 10 9.5 9 8.5 8 7.5 7 6.5 6 5.5
i. Construct a table to show TC, MC, TR and MR.
ii. Using TC-TR approach, find the profit maximizing output level.
iii. What type of market does it indicate? Why?

Solution:
i. Computation of TC, MC, TR and MR
Q AC AR TC MC TR MR
1 7 10 7 - 10 -
2 5 9.5 10 3 19 9
3 4 9 12 2 27 8
4 3.25 8.5 13 1 34 7
5 3 8 15 3 40 6
6 3.1 7.5 18.6 3.6 45 5
7 3.5 7 24.5 5.9 49 4
8 4.2 6.5 33.6 9.1 52 3
9 5 6 45 11.4 54 2
10 6 5.5 60 15 55 1
ii. At output level 6 units, the difference between TR and TC is the greatest. Hence, firm
reaches its equilibrium and maximizes its profit. Here, firm’s maximum profit = $ 26.4 and
profit maximizing output level = 6 units.

iii. The above schedule indicates that this market is monopoly or monopolistic competition. It
is because there is inverse relationship between output and price.

Example 19:
A firm has demand function P = 4 – 2Q, and cost function C = Q2 + 2Q.
Find AC, MC, AR and MR at equilibrium price and quantity.

Solution:
a. Given, demand function P = 4 – 2Q,
Cost function C = Q2 + 2Q
Since, Profit π = TR - TC
Here, TR = PQ = (4 – 2Q)Q = 4Q - 2Q2
Then, π = 4Q - 2Q2 - (Q2 + 2Q)
i.e. π = 4Q - 2Q2 - Q2 - 2Q
∴ π = 2Q – 3Q2

Taking derivative of π with respect to Q, we get,

dπ d (2Q−6 Q)
= =2−6 Q
dQ dQ
dπ
At = 0, 2 – 6Q = 0
dQ
i.e. 2 = 6Q
2 1
∴Q= =
6 3
1
∴ Profit maximizing output Q =
3
Given demand function is P = 4 – 2Q
1
Substituting the value of Q = in the given demand function, we will have
3
1
At Q = , equilibrium price P = 4 – 2
3 ()1
3
=
12−2
3
= Rs.
10
3

2
TC Q + 2Q
b. AC = = =Q+2
Q Q
1 1 7
At Q = , AC = + 2 = Rs.
3 3 3
2
dTC d (Q +2 Q)
c. MC = = = 2Q + 2
dQ dQ
1
At Q = , MC = 2
3
1
3 ()
+ 2 = Rs.
8
3

d. Since, P = AR
 10
∴AR = Rs.
3

At equilibrium, MC = MR
8
∴MR = Rs.
3

Example 20:
Consider the following Table:
Price (Rs.) Quantity TC MC TR MR Profit
11 0 10
10 1 12
9 2 17
8 3 21
7 4 26
6 5 33
5 6 43
4 7 60
3 8 80

a. Complete the above table.

b. Derive the TR curve, TC curve and profit π curve based on the completed table.
c. Identify the profit maximizing level of output and total profit at that level of output.
d. What type of market does it indicate and why?

Solution:
a. Complete the Table:
Price (Rs.) Quantity TC MC TR MR Profit
11 0 10 - 0 - -10
10 1 12 2 10 10 -2
9 2 17 5 18 8 1
8 3 21 4 24 6 3
7 4 26 5 28 4 2
6 5 33 7 30 2 -3
5 6 43 10 30 0 -13
4 7 60 17 28 -2 -32
3 8 80 20 24 -4 -56

b. Derive the TR curve, TC curve and profit π curve based on

the completed table.
TR, TC and π curves can be derived as shown in this Figure.

c. Identify the profit maximizing level of output and total profit

at that level of output.
As can be seen in the Table and Figure, Maximum profit = 3, and profit maximising output
level is 3 units.

d. What type of market does it indicate and why?

The Table indicates an imperfect market type, either monopoly or monopolistic competition,
because there is an inverse relationship between price and quantity of output sold.
Consequently, as output increases, both the Price or AR and MR keep declining .

Example 21:
Consider the following table and solve the questions given below.
Output 0 1 2 3 4 5 6 7 8
TR 0 110 200 270 320 350 360 350 320
TC 200 220 236 248 264 300 360 448 560
Profit

a. Complete the above table.

b. Graph TR, TC and profit π curves and explain the equilibrium condition using TR-TC
approach.
c. Which market does it indicate and why?

Solution:
a. Here we have the completed Table.
Output TR TC Profit
0 0 200 -200
1 110 220 -110
2 200 236 -36
3 270 248 22
4 320 264 56
5 350 300 50
6 360 360 0
7 350 448 -98
8 320 560 -240

b. Graph TR, TC and profit π curves and explain the equilibrium condition using TR-TC
approach.
In the above figure, X-axis represents quantity of output and Y-axis represents total cost and
total revenue and profit. The curves TC, TR and π represent total cost curve, total revenue
curve and total profit curve, respectively. These curves have been derived based on the
completed table. Thus, TR and TC curves are intersecting each other at point A and B. At
points A and B, TC and TR are equal. Therefore, these points are called break-even points.
Before point A and beyond point B, TC .> TR. Therefore, there is loss. Between point A and
B, there is profit, because TR > TC. At 4th unit of output, there is maximum profit or
maximum difference between TR and TC. Therefore, the firm is in equilibrium at 4th unit of
output. At this level of output, the firm’s total profit is equal to Rs.56.

c. Which market does it indicate and why?

This Table shows or indicates imperfect competition (monopoly or monopolistic competition)
because total revenue is increasing at a decreasing rate up to point B and there after it is
falling.

Example 22:
If the cost function of a perfectly competitive firm is given by TC = 4 + 5Q + Q 2 and the
market price of the product is Rs.25, then find the profit maximizing level of output and total
profit of the firm.

Solution
Under perfectly competitive market, AR = MR = P
Here we have from the question, AR = MR = P = Rs.25, and TC = 4 + 5Q + Q2

For profit maximization,

MC = MR
Given TC = 4 + 5Q + Q2
2
d (TC) d (4 +5 Q+Q )
As we know MC = = = 5 + 2Q
Q dQ
Therefore, profit maximization condition MC = MR
5 + 2Q = 25
i.e. 2Q = 25 – 5 = 20 *
i.e. 2Q = 20
20
∴ Q= = 10.
2
Thus, equilibrium quantity, Q = 10 units

As we know, Total profit π = TR - TC

TR = P x Q, and given TC = 4 + 5Q + Q2
∴ π = (25 x 10) – [4 + (5 x 10) + 102)
i.e. = 250 –[4 + 50 + 100]
i.e. = 250 - 154 = Rs.96

Hence, profit maximizing level of output (Q) = 10 units, and total profit π = Rs.96.

Example 23:
The total revenue and total cost functions of a perfectly competitive firm are given as:
TR = 10Q; TC = 100 + 2Q + 0.01Q2
Determine the level of output that maximises profit, and find the total profit at that level of
output.

Solution
We have, TR = 10Q
TC = 100 + 2Q + 0.01Q2

For profit maximization, MC = MR

d (TR) d(10Q)
We know that MR = = = 10
Q dQ
2
d (TC) d (100+2 Q+0.01 Q )
and MC = = = 2 + 0.02Q
Q dQ
Condition for profit maximization is MC = MR
i.e. 10 = 2 + 0.02Q
i.e. 10 – 2 = 0.02 Q = 8 = 0.02Q
8
∴Q= = 400 units
0.02
Thus, eequilibrium quantity, Q = 400 units.

We know that Total profit π = TR – TC

Given TR = 10Q, and TC = 100 + 2Q + 0.01Q2
Therefore, equilibrium profit π = 10Q – [100 + 2Q + 0.01Q2]
Substituting the value of Q = 400 units, we will have
π = (10 x 400) – [100 + (2 x 400) + (0.01x 4002)]
i.e. = 4000 – [100 + 800 + (0.01 x 160000]
i.e. = 4000 – [900 + 1600]
i.e. = 4000 – 2500 = 1500
∴ π = Rs.1500

Hence, total profit is maximized at Q = 400 units, and total profit = Rs.1500

Example 24:
Let the demand function P = 20 - Q and cost function C = Q 2 + 8Q + 4. Find profit
maximizing level of output, price and maximum total profit

Solution
Given Demand function: P = 20 – Q, and Cost function: C = Q2 + 8Q + 4
We know that TR = P x Q
Therefore, TR = (20 – Q)Q = 20Q – Q2
∴ TR = 20Q -Q2

For profit maximization, MR = MC

2
d (TR) d(20Q−Q )
We know that MR = = = 20 – 2Q
Q dQ
2
d (TC) d (Q +8 Q+4 )
and MC = = = 2Q + 8
Q dQ
Therefore, for profit maximization, MR = MC
i.e. 20 – 2Q = 2Q + 8
i.e. 20 – 8 = 2Q + 2Q
i.e. 12 = 4Q
12
Therefore, Q = = 3 units.
4

Profit maximising price, P = 20 – Q

Substituting the value of Q = 3 units, we will have
P = 20 – 3 = 17.
Thus, profit maximising price = Rs.17, and profit maximising quantity Q = 3

We know that Maximum Total Profit = TR – TC

TR = P x Q = 17 x 3 = 51
 And TC = Q2 + 8Q + 4 = [32 + (8 x 3) + 4]
i.e. = 9 + 24 + 4 = 37
Therefore, maximum profit = TR – TC
i.e. = 51 – 37 = 14.
Hence, profit maximising level of output is 3 units, price is Rs. 17, and maximum profit is
Rs.14

Example 25:
Suppose that a firm has the following demand and cost functions: Demand function: P =
2,000 - 10Q and Cost function: C = 1,000 + 200Q
i. Derive TR and MR functions.
ii. Calculate the MC.
iii. Calculate profit maximizing output and price.
iv. Calculate total revenue (TR), total cost (TC) and total profit.

Solution:
Given Demand function: P = 2,000 - 10Q
Cost function: C = 1,000 + 200Q
i. Derive TR and MR functions.
We know that TR = P x Q
Therefore TR = (2000 – 10Q)Q
i.e. = 2000Q – 10Q2
2
d (TR) d(2000Q−10 Q )
We know that MR = = = 2000 – 20Q
Q dQ

ii. Calculate the MC.

Given the cost function C = 1,000 + 200Q
d (TC) d (1000+200 Q)
We know MC = = = 200
Q dQ
iii. Calculate profit maximizing output and price.
For profit maximization, MR = MC
Therefore 2000 – 20Q = 200
i.e. 2000 – 200 = 20Q
i.e. 1800 = 20Q
1800
∴ Q= = 90 units
20
Hence, profit maximising quantity, Q = 90 units
Given demand function P = 2000 – 10Q
Substituting the value of Q, we will have 2000 – 10 x 90
i.e. = 2000 – 900 = 1100
Hence Profit maximising price = Rs.1100

iv. Calculate total revenue (TR), total cost (TC) and total profit.
TR = P x Q
i.e. = 1100 x 90 = Rs.99000
TC = 1,000 + 200Q
i.e. = 1000 + 200 x 90
i.e. = 1000 + 18000 = Rs.19000
Profit = TR – TC
i.e. 99000 – 19000 = 80000
 Thus, profit = Rs.80000.

Example 26:
Let demand function, P = 100 – 4Q, Cost function, TC = 50 + 6Q2.
i. Compute TR, TC and profit at the output range of 0 to 10.
ii. Graph TR, TC and profit curve, and explain TR -TC approach of firm’s equilibrium.

Solution:
Here, P = 100 – 4Q, and TC = 50 + 6Q2.
We know that TR = P x Q
Therefore TR = (100 – 4Q)Q
i.e. TR = 100Q – 4Q2
Given the cost function C = 60 + 7Q2,
The computed TR, TC and profit are shown in this Table and the Graph.
Units TR = 100Q – 4Q2 TC = 60 + 7Q2 Profit
0 0 60 -60
1 96 67 29
2 184 88 96
3 264 123 141
4 336 172 164
5 400 235 165
6 456 312 144
7 504 403 101
8 544 508 36
9 576 627 -51
10 600 760 -160
ii. Graph TR, TC and profit curve, and explain TR -TC approach of firm’s equilibrium.
Total Revenue - Total Cost Approach
According to Total Revenue – Total Cost Approach, profit is the difference between total
revenue and total cost (i.e. π = TR - TC). Thus, a firm is in equilibrium when it produces
output that maximizes the difference between total receipts and total costs. In other words, a
firm is in equilibrium when it is earning maximum profits at a point, where the vertical
difference between TR and TC curves is the greatest. Under imperfect competition (like
monopoly and monopolistic competition), TR increases at a decreasing rate as output
increases. Hence, TR curve slopes upwards to the right and bends towards the X-axis.

According to the traditional concept of cost, total cost increases at a diminishing rate initially
and as output increases, it increases at an increasing rate later. Hence, the TC curve slopes
upwards to the right as inverse-S-Shaped one, as shown in this Figure.

As it can be observed in this Figure:

 At any level of output less than Q 1 and more than Q2, TR < TC. Hence, firm has to
bear loss.
 At output level Q1, TR = TC, where the firm reaches its breakeven. Similarly, at
output level Q2 TR = TC. The firm again reaches its breakeven. However, point E 2 is
considered as rational breakeven point for following two reasons:
a. If firm stops its production at Q1 level, it loses opportunity of attaining economic profit.
a. It is not possible to realize profit at any level of output more than Q2.
  At any level of output between Q 1 and Q2, TR > TC. Hence, firm obtains economic
profit.
 At output level OQ, the vertical distance between the TR curve and the TC curve is
the highest, and therefore profit is at its maximum. The firm, as a profit maximizer,
will be in equilibrium at OQ level of output. Here, profit maximizing output = OQ or
5 units, and maximum profit = AB (= DQ) or Rs.165. If the firm produces any output
more than 5 units, the total profit will decline, since after the gap between TR and TC
curves goes on declining. It may be noted that at point Q, slope of TR curve and TC
curve are equal.
 By considering vertical distance between TR and TC curves, profit curve ( π ) can be
derived. The level of output at which this profit curve stands highest from the X-axis
(shown by point D) will be profit maximizing level of output.

Example 27:
The firm’s cost and revenue functions are given as C = 25 + 3Q2: P = 50 – 2Q
Find profit maximising output and total profit.

Solution:
Given C = 25 + 3Q2: P = 50 – 2Q
We know that π For profit maximisation MR = MC

We also know that TR = P x Q

i.e. = (50 – 2Q) x Q
i.e. TR = 50Q – 2Q2
2
dTR d (50 Q−2 Q )
We know that MR = = = 50 – 4Q
dQ dQ
Therefore, MR = 50 – 4Q
Given TC = 25 + 3Q2
2
dTC d (25−3 Q )
We know that MC = = = – 6Q
dQ dQ
We know that π For profit maximisation MR = MC
i.e. 50 – 4Q = -6Q
i.e. 50 = 10Q
50
Therefore, Q = = 5.
10
Thus profit maximising output = 5 units.

Total profit = TR - TC
Substituting the value of output = 5 units in TR = 50Q – 2Q2
We will have TR = (50 x 5) – (2 x 52)
i.e. TR = 250 – 50 = 200
Thus, TR = Rs.200
Substituting the value of output = 5 units in TC = 25 + 3Q2
We will have TC = 25 + (3 x 52)
i.e. TC = 25 + 75 = 100
Thus, TC = Rs.100
Therefore profit, π = TR – TC = 200 – 100 = 100
Thus, profit maximising output = 5 units, and the total profit = Rs.100
Example 28:
a. Complete the above Table
b. Find profit maximising output by TR and TC approach
c. Find profit maximising output from MR and MC approach
d. What is the relationship between MC and Price at 7 units of output.
Profi
Output Price TR TC t MR MC
1 10 12
2 10 14
3 10 15
4 10 17
5 10 20
6 10 25
7 10 35
8 10 50

Solution:
a. The completed Table is presented here.
Output Price TR TC Profit MR MC
1 10 10 12 -2 10 -
2 10 20 14 6 10 2
3 10 30 15 15 10 1
4 10 40 17 23 10 2
5 10 50 20 30 10 3
6 10 60 25 35 10 5
7 10 70 35 35 10 10
8 10 80 50 30 10 15
b. Find profit maximising output by TR and TC approach
According to Total Revenue – Total Cost Approach, profit is the difference between total
revenue and total cost (i.e. π = TR - TC). Thus, a firm is in equilibrium when it produces
output that maximizes the difference between total receipts and total costs. In other words, a
firm is in equilibrium when it is earning maximum profits at a point, where the difference
between TR and TC is the greatest. Here, as can be observed in the Table, profit is the
maximum of Rs.35 at 6th and 7th unit of output is sold.

c. Find profit maximising output from MR and MC approach

According to MR – MC Approach, the firm is in equilibrium when MC = MR, and the firm
has tendency to either increase or decrease the output, and it is said to be in a state of
equilibrium. Therefore, in our Table here, MC(i.e. Rs.10) = MR(i.e. Rs.10), when the firm
produces and sells 7 units of output, and earns a profit π = TR(i.e. Rs.70) – TC (i.e. Rs.i.e.35)
= Rs.35.

d. What is the relationship between MC and Price at 7 units of output.

As can be seen in this Table, at the 7th unit of output, MC (i.e. Rs.10) = Price (i.e. Rs.10).

Example 29:
Consider the following Schedule:
 Output 0 1 2 3 54 6 7 8
35 35 32
TR 0 110 200 270 320 0 360 0 0
30 44 56
TC 200 220 236 248 264 0 360 8 0
Graph TR and TC curves and explain the equilibrium of the firm according to TR and TC
approach.

Solution:
The Figure here presents the TR and TC curves pertaining the given Table.

According to Total Revenue – Total Cost Approach, profit is the difference between total
revenue and total cost (i.e. π = TR - TC). Thus, a firm is in equilibrium when it produces
output that maximizes the difference between total
receipts and total costs. In other words, a firm is in
equilibrium when it is earning maximum profits at a
point, where the vertical difference between TR and TC
curves is the greatest. As can be observed, TR curve
slopes upwards to the right and bends towards the X-axis.
On the other hand, the TC curve slopes upwards to the
right as inverse-S-Shaped one, as shown in this Figure.

We can observe the following in this Figure:

 At any level of output less than E1 and more than
E2, TR < TC. Hence, firm has to bear loss.
 At point E1, TR = TC, where the firm reaches its breakeven. Similarly, at point E 2 TR
= TC, where the firm again reaches its breakeven. However, point E 2 is considered as
rational breakeven point for following two reasons:
a. If firm stops its production at E1 level, it loses the opportunity of attaining economic profit.
a. It is not possible to realize profit at any level of output more than Q2.

 At any level between E1 and E2, TR > TC. Hence, firm obtains economic profit.
 At output level of 4 units, the vertical distance between the TR curve and the TC
curve is the highest, and therefore profit is at its maximum. The firm, as a profit
maximizer, will be in equilibrium at units of output. Here, profit maximizing output =
4 units, and maximum profit = AB or Rs.56. If the firm produces any output more
than 4 units, the total profit will decline, since after the gap between TR and TC
curves goes on declining. It may be noted that at the output level of 4 units, slope of
TR curve and TC curve are equal.

Example30:
The following Table shows output and total cost of a perfectly competitive firm:
Output Price TC TR Profit
0 30 20
1 30 30
2 30 45
3 30 65
4 30 90
5 30 125
 6 30 160
7 30 220
a. Complete the Table, and Graph TC and TR curves
b. Explain the equilibrium of the firm according to TR and TC approach.

Solution:
The completed Table is presented here, and the TR and TC curves are shown as in this Figure
Output Price TC TR Profit
0 30 20 0 -20
1 30 30 30 0
2 30 45 60 15
3 30 65 90 25
4 30 90 120 30
5 30 125 150 25
6 30 160 180 20
7 30 220 210 -10

The Figure here presents the TR and TC curves

pertaining the given Table.

According to Total Revenue – Total Cost Approach, profit is the difference between total
revenue and total cost (i.e. π = TR - TC). Thus, a firm is in equilibrium when it produces
output that maximizes the difference between total receipts and total costs. In other words, a
firm is in equilibrium when it is earning maximum profit at a point, where the vertical
difference between TR and TC curves is the greatest. As can be observed, since this firm is
under perfect competition, TR curve is an upward sloping to the right as a straight line. On
the other hand, the TC curve slopes upwards to the right as inverse-S-Shaped one, as shown
in this Figure.

We can observe the following in this Figure:

 At any level of output less than E 1 and more than E2, TR < TC. Hence, firm has to
bear loss.
 At point E1, TR = TC, where the firm reaches its breakeven. Similarly, at point E 2 TR
= TC, where the firm again reaches its breakeven. However, point E 2 is considered as
rational breakeven point for following two reasons:
a. If firm stops its production at E1 level, it loses the opportunity of attaining economic profit.
a. It is not possible to realize profit at any level of output more than Q2.

 At any level between E1 and E2, TR > TC. Hence, firm obtains economic profit.
 At output level of 4 units, the vertical distance between the TR curve and the TC
curve is the highest, and therefore profit is at its maximum. The firm, as a profit
maximizer, will be in equilibrium at units of output. Here, profit maximizing output =
4 units, and maximum profit = AB or Rs.30. If the firm produces any output more
than 4 units, the total profit will decline, since the gap between TR and TC curves
goes on declining beyond point B. It may be noted that at the output level of 4 units,
slope of TR curve and TC curve are equal.

Example 31:
A perfectly competitive firm has the following total cost:
Q 0 1 2 3 4 5 6
TC 20 30 42 55 69 84 100
How much will the firm produce if the price of the product is Rs.14 per unit? How will it
change its output if price per unit rises to Rs.16.

Solution:
Given the Total Cost, we can calculate the TR, MR and MC as shown in the Table

When the price is Rs.14, this firm working under perfectly competitive market, will achieve
its equilibrium output, where its MC = MR. As seen in the Table, MC (i.e. Rs.14) = MR (i.e.
Rs.14), when the firm produces 4 units of output. When the price of the product is Rs.14, this
firm will produce till the 4th unit. If this produces beyond 4 units, its MC > MR, and any unit
below 4 units will imply that its MR > MC.

If the price increases to Rs.16 per unit, then as can be seen in the Table to the right, this
firm’s MC(i.e. Rs.16) = MR(i.e. Rs.16) when this firm produces 6 th unit. If it produces
beyond 6th unit, its MC > MR, and if it stops production before its 6th unit, its MR < MC.
Therefore, when the price is Rs.14, it will produce up to
Pric
the 4th unit, and when the price increases to Rs.16, it will
Q e TR TC MR MC
produce up to 6th unit.
0 16 - 20 - -
1 16 16 30 16 10
2 16 32 42 16 12
Example 32: 3 16 48 55 16 13
2
Let, cost function, C = 60 + 7Q , and demand function, P = 4 16 64 69 16 14
120 - 5Q. (i) 5 16 80 84 16 15
Pric Compute TR, TC
Q e TR TC MR MC and profits up to 6 16 96 100 16 16
0 14 - 20 - - output level 15 units, graph them and determine
1 14 14 30 14 10 profit maximizing output and maximum profit, (ii)
Compute MR and MC up to output level 15 units,
2 14 28 42 14 12
graph them and determine profit maximizing output.
3 14 42 55 14 13
4 14 56 69 14 14 Solution:
5 14 70 84 14 15 i) Compute TR, TC and profits up to output level 15
6 14 84 100 14 16 units, graph them and determine profit maximizing
output and maximum profit.

Given cost function, C = 60 + 7Q2, and demand function, P = 120 - 5Q.

We know that TR = P x Q
Therefore TR = (120 – 5Q)Q
i.e. = 120Q – 5Q2

Given the cost function C = 60 + 7Q2,

The computed TR, TC and profit are shown in this
Table and the Graph.
Q TR TC Profit MR MC
 0 0 60 0 - -
1 115 67 48 115 7
2 220 88 132 105 21
3 315 123 192 95 35
4 400 172 228 85 49
5 475 235 240 75 63
6 540 312 228 65 77
7 595 403 192 55 91
8 640 508 132 45 105
9 675 627 48 35 119
10 700 760 -60 25 133
11 715 907 -192 15 147
12 720 1068 -348 5 161
13 715 1243 -528 -5 175
14 700 1432 -732 -15 189
15 675 1635 -960 -25 203
Calculate profit maximizing output and price.

For profit maximization, MR = MC

Given TR =120Q – 5Q2 and TC = 60 + 7Q2
2
d (TR) d(120Q−5 Q )
We know that MR = = = 120 – 10Q
Q dQ

Given the cost function C = 60 + 7Q2

d (TC)
We know MC = =¿ ¿ = 14Q
Q

For profit maximization, MR = MC

Therefore 120 – 10Q = 14Q
i.e. 120 = 24Q
120
∴ Q= = 5 units
24
Hence, profit maximising quantity, Q = 5 units
Given demand function P = 120 - 5Q
Substituting the value of Q = 5, we will have 120 – 5 x 5
i.e. = 120 – 25 = 95
Hence Profit maximising price = Rs.95

Thus, profit maximising price = Rs.95, and

profit maximising quantity Q = 5

We know that Maximum Total Profit = TR – TC

TR = 120Q – 5Q2
Substituting the value of Q = 5,
We will have (120 x 5) – (5 x 52)
i.e. = 600 – 125 = 475
 Given TC = 60 + 7Q2
Substituting the value of Q = 5,
= 60 + (7 x 52)
= 60 + (175) = 235
Therefore, maximum profit = TR – TC
i.e. = 475 – 235 = 240.
Hence, profit maximising level of output = 5 units, price = Rs. 95, and maximum profit =
Rs.240

(ii) Compute MR and MC up to output level 15 units, graph them and determine profit
maximizing output.
As can be seen in this graph, profit maximising output is 5 units.

Example 33:
Given the following cost data, assume that you cannot produce fractions of a unit:
Q 0 1 2 3 4 5 6
TFC 12 12 12 12 12 12 12
TVC 0 5 9 14 20 28 38
i. If the price of output is Rs.8, how many units of output will this firm produce? What is total
revenue? What is total cost? What is the total profit?
ii. Will the firm operate or shut down in the short run at price (a) Rs.4.50 (ii) Rs.4. Briefly
explain.

Solution:
i. If the price of output is Rs.8, how many units of output will this firm produce? What is total
revenue? What is total cost? What is the total profit?

If the price is fixed at Rs.8 per unit, this firm is working under perfectly competitive market,
and as we know, equilibrium condition is MC = MR

As we can observe from this Table, MC = MR, when this firm produces 5 units, where TR =
Rs.40, and TC = Rs.40, and total profit = 0 or normal profit. Thus we can conclude that this
firm will produce 5 units, if the price is Rs.8
Pric AC AVC
e Output TFC TVC TC MC TR MR Profit
8 0 12 0 12 - 0 - -12 - -
8 1 12 5 17 5 8 8 -9 17.0 5.0
8 2 12 9 21 4 16 8 -5 10.5 4.5
8 3 12 14 26 5 24 8 -2 8.7 4.7
8 4 12 20 32 6 32 8 0 8.0 5.0
8 5 12 28 40 8 40 8 0 8.0 5.6
8 6 12 38 50 10 48 8 -2 8.3 6.3
ii. Will the firm operate or shut down in the short run at price (a) Rs.4.50 (ii) Rs.4. Briefly
explain.
A firm has to analyze two possibilities while making decision about shutting down of a firm
incurring loss in the short run:
 (i) The firm gets price (average revenue) less than average total cost (AC), but greater than
average variable cost (AVC < P < AC).
(ii) The firm gets price (average revenue) even less than average variable cost (P < AVC)

(a) Although a firm may incur loss in the short run, as

long as revenue can cover the variable cost, it will
continue its production. It is because each unit of output
provides at least some profit contribution to cover fixed
costs and provides profit. The firm prefers to earn at least
some profit contribution to cover a portion of total fixed
costs, rather than shut down. Therefore, if the price is
Rs.4.50, the firm will continue to produce till the 2 nd unit
where the price 4.50 equals the AVC. However, beyond
the 2nd unit, since the price of Rs.4.50 is less than AVC,
the firm will shut down.
(b) In the second case, where price = Rs.4, the firm will
shut down because the revenue cannot cover even its variable cost. In this situation, (i.e. P <
AVC) shut down decision assures the loss equal only to total fixed cost as it is evident from
this Figure.
Example 34:
Consider the following Table:
Price Quantity TC MC TR MR Profit
11 0 10
10 1 12
9 2 17
8 3 21
7 4 26
6 5 33
5 6 43
4 7 60
3 8 80
a. Complete the above Table
b. Derive the TR and TC curves according to the Table
c. Derive profit and identify the maximum profit.

Solution:
The completed Table is presented here:
Pric M T M Profi
e Quantity TC C R R t
11 0 10 - - - -10
10 1 12 2 10 10 -2
9 2 17 5 18 8 1
8 3 21 4 24 6 3
7 4 26 5 28 4 2
6 5 33 7 30 2 -3
5 6 43 10 30 0 -13
4 7 60 17 28 -2 -32
 3 8 80 20 24 -4 -56

b. The TR and TC curves according to the Table can be seen in this Figure
c. Derive profit and identify the maximum profit.
Maximum profit of Rs.3 is achieved by this firm, when it sells 3 units at Rs.8 per unit, where
the TR earned by this firm is Rs.24, and the TC = Rs.21.

Example 35:
The Woodcutter’s Ltd, runs a tree cutting service. Its total cost function is: TC = 200 + 4Q +
2Q2. Is the given function the firm's short run total cost curve or its long run total cost curve?
Give reasons.

What is the firm's total fixed cost?

What is the firm's total variable cost function?
What is the firm's marginal cost function?
What is the firm's average total cost function?
If the firm is perfectly competitive and the market rate for cutting trees is Rs.24, what is its
profit-maximising output rate?
At this output, is the firm earning a profit or making a loss? If it is making a loss, should the
firm temporarily stop operating in the short run?

Solution:
As we know, in the short run, there are fixed costs and variable costs. In the short-run, while
the fixed cost remains constant, output can be increased by increasing variable factors. The
given total cost function TC = 200 + 4Q + 2Q 2 is the firm's short run total cost curve, since
the constant 200 refers to Fixed cost and 4Q + 2Q 2 refers to variable cost. The firm’s fixed
cost is Rs.200, and the variable cost function is 4Q + 2Q 2. Given the cost function TC = 200
d (TC)
+ 4Q + 2Q2. We know MC = =¿ ¿ = 4 + 4Q. Therefore, Marginal Cost function is 4 +
Q
2
TC 200+4 Q+ 2Q 200
4Q. Average cost function is = = = + 4+ 4 Q
Q Q Q

We know that TR = P x Q
Given P = Rs.24
Therefore TR = 24 x Q = 24Q
d (TR) d(24 Q)
We know MR = = = 24
Q dQ
Given cost function, TC = 200 + 4Q + 2Q2
2
d (TC) d (200+ 4 Q+2 Q )
We know MC = = = 4 + 4Q
Q dQ

For profit maximization, MR = MC

Therefore 24 = 4 + 4Q
i.e. 24 - 4 = 4Q
20
∴ Q= = 5 units
4
Hence, profit maximising quantity, Q = 5 units

We know that Maximum Total Profit = TR – TC

 TR = 24Q
Substituting the value of Q = 5,
We will have (24 x 5) = 120

Given TC = 200 + 4Q + 2Q2

Substituting the value of Q = 5,
= 200 + 4 x 5 + (2 x 52)
= 200 + 20 + 50 = 270
Therefore, maximum profit = TR – TC
i.e. = 120 – 270 = - 150.
Hence, at the output of 5 units, this firm is incurring a loss of Rs. 150.

In order to arrive at the decision to continue production or shut down, we need to see if the P
< AVC. If P < AVC, then the firm should shut down its production, and if P > AVC, then it
can continue the production, irrespective of the loss, since at the given price of Rs.24, it can
at least cover the variable cost, and leave a contribution margin to cover at least part of the
fixed costs, in the short run.

In the given TC = 200 + 4Q + 2Q2, variable cost function is 4Q + 2Q2

2 ¿
Therefore, AVC = 4 Q+2Q ¿ Q =4+ 2Q
Therefore, AVC = 4 + 2Q
Substituting the value of Q = 5, we will have
AVC = 4 + (2 x 5) = 4 + 10 = 14.

As we can see price = Rs.24, and AVC = 14. Since P > AVC, this firm can continue its
production, irrespective of incurring loss.
Example 36:
Consider the following schedule of a competitive firm: (10+5)
Output 1 2 3 4 5 6 7 8
AVC 30 27 24 24 30 39.9 53.1 67.5
AC 330 177 123.9 99 90 90 96 105
MC 30 24 18 24 54 90 132 168

i. Graph AVC, AC and MC. ii. What is the position of firm's profit at price Rs.132, Rs.90,
and Rs.54? iii. What is the position of firm at price Rs.24? Does this point refer to the shut-
down point? Give reason.
Using the cost schedule, explain the relationship of AC with
AVC and AFC.

Solution:
i. When we graph AVC, AC and MC, we will have this
Figure:

ii. What is the position of firm's profit at price Rs.132, Rs.90,

and Rs.54?

As we know, Profit π = TR - TC
(a) Here we have, P = Rs.132, Rs.90, and Rs.54
We know that TR = P x Q, and TC = AC x Q
If Price, P = Rs.132, TR = 132 x Q
i.e. TR = 132Q
d (TR) d(132Q)
We know MR = = = 132
Q dQ
i.e. MR = Rs.132
We know that for equilibrium, MC = MR
With the given schedule, we find that MC = 132, when the firm produces 7 units, where we
find that MC = MR = 132.
We know that for a firm under perfect competition, MR = AR = 132.
Therefore at 7 units, TR = AR x Q
i.e. = 132 x 7 = Rs.924
At 7 units, AC = 96
Therefore, at 7 units, TC = AC x Q
i.e. = 96 x 7 = Rs.672
Therefore, since Profit π = TR – TC
i.e. = 924 - 672 = Rs.252
Therefore, Profit π = Rs.252
Thus, when price = Rs.132, this firm makes a supernormal profit of Rs.252

(b) If Price, P = Rs.90, TR = 90 x Q

i.e. TR = 90Q
d (TR) d(90 Q)
We know MR = = = 90
Q dQ
i.e. MR = Rs.90
We know that for equilibrium, MC = MR
With the given schedule, we know that MC = 90, when the firm produces 6 units, where we
find that MC = MR = 90.
We know that for a firm under perfect competition, MR = AR = 90.
Therefore at 6 units, TR = AR x Q
i.e. = 90 x 6 = Rs.540
At 6 units, AC = 90
Therefore, at 6 units, TC = AC x Q
i.e. = 90 x 6 = Rs.540
Therefore, since Profit π = TR – TC
i.e. = 540 - 540 = 0
Therefore, Profit π = Rs.0
Thus, when price = Rs.90, this firm earns only normal profit.

(c) If Price, P = Rs.54, TR = 54 x Q

i.e. TR = 54Q
d (TR) d(54 Q)
We know MR = = = 54
Q dQ
i.e. MR = Rs.54
We know that for equilibrium, MC = MR
With the given schedule, we know that MC = 54, when the firm produces 5 units, where we
find that MC = MR = 54.
We know that for a firm under perfect competition, MR = AR = 54.
Therefore at 5 units, TR = AR x Q
i.e. = 54 x 5 = Rs.270
 At 5 units, AC = 90
Therefore, at 5 units, TC = AC x Q
i.e. = 90 x 5 = Rs.450
Therefore, since Profit π = TR – TC
i.e. = 270 - 450 = - 180
π
Therefore, Profit = - Rs.180
Thus, when price = Rs.54, this firm makes a loss of Rs.180

iii. What is the position of firm at price Rs.24? Does this point refer to the shut-down point?
Give reason.

If Price, P = Rs.24, TR = 24 x Q
i.e. TR = 24Q
d (TR) d(24 Q)
We know MR = = = 24
Q dQ
i.e. MR = Rs.24
We know that for equilibrium, MC = MR
With the given schedule, we know that MC = 24, when the firm produces 4 units, where we
find that MC = MR = 24.
We know that for a firm under perfect competition, MR = AR = 24.
Therefore at 4 units, TR = AR x Q
i.e. = 24 x 4 = Rs.96
At 4 units, AC = 99
Therefore, at 4 units, TC = AC x Q
i.e. = 99 x 4 = Rs.396
Therefore, since Profit π = TR – TC
i.e. = 96 - 396 = - 300
Therefore, Profit π = - Rs.300
Thus, when price = Rs.24, this firm incurs a loss of Rs.300

Besides this firm incurring loss of Rs.300, it may be noted that AR or Price (Rs.24) = AVC
(Rs.24) < AC (99).

Therefore, in order to arrive at the decision on whether to continue production or shut down,
we need to see if the P > AVC. If P < AVC, then the firm should shut down its production,
and if P > AVC, then it can continue the production, irrespective of the loss, since at the
given price of Rs.24, it can at least cover the variable cost, and leave a contribution margin to
cover at least part of the fixed costs, in the short run. Here since P = AVC, it implies that this
firm will recover only its variable cost, and will compel to bear its losses on fixed cost. The
firm, therefore, would be indifferent between closing down or producing 4 units of output.
However, if P < AVC, the firm will shut down, since the firm has to bear loss even the
variable costs. Hence, the output of 4 units, where P and AVC are equal at Rs.24 is known as
the shut-down point or close-down point.

Total Revenue - Total Cost Approach

According to Total Revenue – Total Cost Approach,
profit is the difference between total revenue and
total cost (i.e. π = TR - TC). Thus, a firm is in
equilibrium when it produces output that maximizes
the difference between total receipts and total costs.
In other words, a firm is in equilibrium when it is earning maximum profits at a point, where
the vertical difference between TR and TC curves is the greatest. Under imperfect
competition (like monopoly and monopolistic competition), TR increases at a decreasing rate
as output increases. Hence, TR curve slopes upwards to the right and bends towards the X-
axis.

According to the traditional concept of cost, total cost increases at a diminishing rate initially
and as output increases, it increases at an increasing rate later. Hence, the TC curve slopes
upwards to the right as inverse-S-Shaped one, as shown in this Figure.

As it can be observed in this Figure:

 At any level of output less than Q 1 and more than Q2, TR < TC. Hence, firm has to
bear loss.
 At output level Q1, TR = TC, where the firm reaches its breakeven. Similarly, at
output level Q2 TR = TC. The firm again reaches its breakeven. However, point E 2 is
considered as rational breakeven point for following two reasons:
a. If firm stops its production at Q1 level, it loses opportunity of attaining economic profit.
a. It is not possible to realize profit at any level of output more than Q2.

 At any level of output between Q 1 and Q2, TR > TC. Hence, firm obtains economic
profit.
 At output level OQ, the vertical distance between the TR curve and the TC curve is
the highest, and therefore profit is at its maximum. The firm, as a profit maximizer,
will be in equilibrium at OQ level of output. Here, profit maximizing output = OQ or
5 units, and maximum profit = AB (= DQ) or Rs.165. If the firm produces any output
more than 5 units, the total profit will decline, since after the gap between TR and TC
curves goes on declining. It may be noted that at point Q, slope of TR curve and TC
curve are equal.
 By considering vertical distance between TR and TC curves, profit curve ( π ) can be
derived. The level of output at which this profit curve stands highest from the X-axis
(shown by point D) will be profit maximizing level of output.

Summary of Chapter 7
 Meaning of Perfectly Competitive Market: Perfect competitive market is that
market structure in which there are large number of sellers and buyers of
homogeneous products with perfect substitutes.
 Characteristics of Perfect competition: It is characterized by (i) large number of
buyers and sellers (ii) product homogeneity with perfect substitutes (iii) free entry and
exit of firm (iv) perfect knowledge about market (v) perfect mobility of factors of
production (vi) horizontal demand curve (vii) no government regulation (viii) absence
of transport cost (ix) objective of firm - profit maximization O Monopoly
 Monopoly is a market structure in which there is a single seller, there are no close
substitutes for the commodity it produces, and there are barriers to entry.
 Causes of Monopoly: The main causes that lead to monopoly are listed as: (i)
strategic raw material (ii) patent rights (iii) limit pricing policy (iv) existence of
goodwill (v) legal restrictions (vi) local monopolies (vii) optimal scale of plant O
Characteristics of Monopoly.
 The main characteristics of monopoly are: (i) single seller and large number of
buyers (ii) no close substitutes (iii) barriers to entry of new firms (iv) informative
selling cost (v) price maker (vi) negative sloping demand curve (vii) objective of firm
- profit maximization. The firm determines its level of output at a point where the two
conditions for profit maximization (i.e. MC = MR, slope of MC > slope of MR) are
satisfied. It determines price of the product on the basis of law of demand.
 Monopolistic Competition: Monopolistic competition is that form of market in
which there are many sellers of a particular product, but each seller sells somewhat
differentiated product.
 Characteristics of Monopolistic Competition: The main characteristics of
monopolistic competition are listed as: (i) large number of buyers and sellers (ii)
differentiated products (iii) free entry and exit of firms (iv) non-price competition and
selling costs (v) negative sloping demand curve (vi) objective of firm - profit
maximization. The firm determines its total output at a point where it reaches at
equilibrium by satisfying following two conditions for profit maximization: (i) MC =
MR (ii) slope of MC > slope of MR. It determines price of product on the basis of law
of demand. It also formulates sales strategies to participate in non-price competition.
The firm obtains normal profit in long run. It is due to the condition of free entry and
exit of firm. It operates its plant only at sub-optional capacity. It is due to the market
imperfections.
 Oligopoly: Oligopoly refers to that situation in which there are a few enough sellers
of particular product (either homogenous or differentiated). It can be classified on
different bases: (i) basis of product differentiation (ii) basis of entry of firms (iii) basis
of price leadership (iv) basis of agreement
 Sources of Oligopoly: The main sources (or causes) of oligopoly are listed as: (i)
huge capital investment (ii) economies of scale (iii) patent rights (iv) control over
certain raw materials (v) merger and takeover
 Features of Oligopoly: The main features of oligopoly are listed as: (i) small number
of sellers (ii) interdependence of decision-making (iii) barriers to entry (iv) excessive
expenditure on advertisement (v) indeterminate price and output.
 Profit Maximization goal of firm: Classical economists believed that profit
maximization is the sole objective of the firm. According to this model, the firm will
be in equilibrium when it obtains maximum profit from the employment of its given
resources. It is classical but most dominant objective of business firms.
 Short-run supply curve of firm: short nm supply curve of a competitive firm is a
locus representing various equilibrium points at MC = P at various prices. In other
words, short run supply curve represents the portion of the firm's marginal cost curve
which lies above its minimum point of AVC curve. The industry's supply curve is
derived by the horizontal summation of the supply curves of the individual firms.
 Price discrimination: Price discrimination refers to a situation when a producer sells
the same product to different buyers at different prices for reasons not associated with
differences in costs. It is mainly adopted to achieve three goals: (i) profit / sales
maximization (iii) to promote public welfare (iv) to provide incentive to less
developed economic sector
 Conditions for Price Discrimination: The main conditions for price discrimination
are: (i) monopoly market (ii) segregation of market into different sub-markets on the
basis of price elasticities, and (iii) no chance of reselling
 Forms of Price Discrimination: The common forms of price discrimination are: (i)
personal discrimination (ii) age discrimination (iii) sex discrimination (iv) locational
 discrimination (v) size discrimination (vi) quality variation discrimination (vii) use
discrimination (viii) time discrimination
 Degrees of Price Discrimination: There are three degrees of price discrimination: (i)
first degree or perfect discrimination (ii) second degree price discrimination (iii) third
degree price discrimination
 Damping: Dumping is an art of selling a commodity at a lower price in a foreign
market and at a higher price in the home market.
 Cartel: A cartel is a formal organization of the oligopoly firms in an industry. The
main goal of cartel is to centralize certain managerial decisions and function of
individual firms in the industry with a view to promoting common benefits.
 Cost Plus Pricing: Cost plus pricing in one of the short-cut and popular method of
pricing where the price of a product is determined by adding a pre-determined
“markup” to a firm’s estimated per unit cost of production to cover overhead costs
and attain profits.
 Incremental Cost Pricing: In another pricing practice, the producer determines price of
a product along with its output if the increase in total revenue i.e. incremental revenue
exceeds incremental cost. Firm also looks after this concept at the time of introduction
of new product.
 Administered Pricing: The concept administered is used in two ways. First, as
introduced by Keynes, the prices charged by a monopolist and, determined by
considerations other than marginal cost is administered price. Second concept gives a
slightly different meaning of administered prices. An administered price for a
commodity is the one which is decided and arbitrarily fixed by the government.
 Export Pricing: Export pricing relates to pricing of products exported by the firm. Its
decision is based in view of international marketing. World market is complex,
competitive and sensitive.
 Predatory Pricing: Predatory pricing is one of the common practices in competitive
market environment It is the act of setting prices very low to eliminate the
competition. Dominant firm in the competitive market deliberately set very low price
of the commodity in order to prevent competition.
 Skimming Pricing: A skimming price is that where the initial price is high.
Whenever a company introduce a new product, it spends a huge sum of money on
advertisements. The company may put the product in attractive packages. Therefore,
to cover all these costs, the company fixes a high price.
 Penetration Pricing: A low penetration price pertains to charging a low price in the
beginning itself. If the price is low, it can penetrate into the market quickly. It is due
to the fact that the consumers may buy the product at a km price.

Brief Answer Questions

1. State the features of homogenous product.
2. All competitive firms obtain normal profit in long run. Why?
3. Competition firms are called optimum firm. Why?
4. What are the conditions for industry equilibrium?
5. What are the conditions of firm equilibrium?
6. Define monopoly.
7. Define patent right monopoly.
8. Define legal monopoly.
9. Define discriminating monopoly.
10. Write any five assumptions of monopoly.
11. Write any two examples of price discrimination.
12. What are the conditions of price discrimination?
13. What are the objectives of price discrimination?
14. State the basis of pricing under third degree price discrimination.
15. State the conditions for first degree of price discrimination.
16. State the conditions for second degree of price discrimination.
17. Define dumping.
18. What are the differences between simple monopoly and discriminating monopoly?
19. Do you agree that there is distinction between firm and industry under monopoly?
20. Does monopoly firm obtain only excess profit in short run? Give reasons.
21. Define oligopoly.
22. Write any two examples of oligopoly market in Nepal.
23. What are the conditions for raising oligopoly market?
24. What are the advantages of dumping?
25. Do you agree that perfect competition leads to optimum size of the firm? Give reasons.
26. Industry supply curve, in short run, is a horizontal summation of its firm's supply curves.
Justify.
27. Suppose a competition firm is in long run equilibrium. What will happen to price in the
long run if there is a rise in demand for the product of the industry?
28. Write a short note on the relationship between firm's SMC curve and supply curve.
29. Show how under the condition of perfect competition in the long run, the price of a
commodity equal to its average and marginal cost.
30. There is an element of monopoly in monopolistic competition. What factors give
monopoly power to a firm in monopolistic competition?
31. Why do firms in monopolistic competition incur selling costs?
32. Give two examples of selling costs.
33. Suppose a monopoly firm facing a demand curve with negative slope has its price fixed at
Rs- 100 where e = 1. Compute marginal revenue.
34. Suppose a simple monopolist is in equilibrium. At the point of equilibrium, the
coefficient of price elasticity is 2 and marginal cost is Rs.4. Calculate monopoly's equilibrium
price.
35. A monopolistic firm may earn normal or abnormal profit or may even incur losses in the
short run. Do you agree with this statement? Give reasons for your answer.
37. Suppose price charged by a monopolist at equilibrium is twice as high as its MC. What is
the price elasticity of demand?
38. Show the difference between the long run equilibrium of a competitive firm and
monopoly firm with regard to the (i) profit and (ii) use of capacity.
39. What are the characteristics of oligopoly?
40. State the geometrical condition for profit maximization under TR - TC approach.
41. What is meant by non-price competition?
42. Define selling costs?
43. Write the examples of selling costs.
44. Define differentiated product.
45. State the features of differentiated product.
46. All firms obtain normal profits in long run under monopolistic competition. Why?
47. Do you agree that all competitive firms obtain excess profit in short run?
48. Write any four characteristics of perfect competition.
49. Write any four characteristics of monopoly.
50. Write any four characteristics of monopolistic competition.
51. Define the shape of demand curve of monopolistic firm with proper reasons.
52. What forces limit the monopolist's market power in the real world?
53. Why would a monopolist advertise its product if it has a monopoly power over the
product?
54. Why might a competitive firm remain in business in the short run even if increasing a
loss, but will always leave the industry it incurring a loss in the long run.
55. A firm’s total revenue is $100, its total cost is $120, and its total fixed cost is $40. Should
the firm stay in business? Why?
56. How does the shape of the monopolist's total revenue curve differ from that of a perfectly
competitive firm?
57. Why would a monopolist never operate in the inelastic range of its demand curve?
58. Why does excess capacity arise in monopolistic competition?
59. Is advertising good or bad for consumers? Why?
60. Define cartel.
61. Write short notes on:
i. Cost plus pricing, ii. Incremental cost pricing, iii. Administered pricing, iv. Export pricing,
v. Predatory pricing, vi. Skimming pricing, vii. Penetration pricing.

Descriptive answer Questions:

1. Explain the characteristics of perfect competition market.
2. Why is the firm demand curve horizontal in perfectly competitive markets? Does this mean
that the perfectly competitive industry demand curve is also horizontal?
3. Explain the competitive market equilibrium with the help of numerical equations.
4. Why does some firms get excess profit, some firms get normal profit and some firms
suffers from loss in short run and all firms get only the normal profit in long rim in perfect
competition?
5. “In perfect competition, a firm incurring loss in short run does not shut down until the
price equals to the minimum point of average variable cost?" Explain.
6. Derive supply curve of a firm in short run.
7. Derive supply curve of an industry in short run.
8. How does a firm attain equilibrium approach under monopoly?
9. Describe the monopoly market structure and provide some examples.
10. Explain the types of monopoly market.
11. Explain the factors which raises monopoly power.
12. Why does some firms get excess profit, some firms get normal profit and some firms
suffer loss in the short run and all firms get only the excess profit in the long run monopoly?
13. Explain first degree price discrimination.
14. Explain second degree price discrimination
15. How is price determined in international price discrimination?
16. Explain the characteristics of monopolistic market
17. Why does some firms get excess profit, some firms get normal profit and some firms
suffer loss in the short run and all firms get only normal profit in the long run in as
monopolistic market?
18. A monopolistic firm always has excess capacity? Explain.
19. Explain the characteristics of oligopoly market.

Analytical Answer Questions:

1. Explain the profit maximization goal of firm.
2. How do the firms and industry attain equilibrium in perfect competition market in short
run?
3. How do the firms and industry attain equilibrium in perfect competition market in long
run?
4. How do the price and out are determined in monopoly market in short run?
5. How do the price and out are determined in monopoly market in long run?
6. How does a firm determine discriminating price in different sub markets?
7. How do the price and out are determined in monopolistic market in short run?
8. How do the price and out are determined in monopolistic market in long run?
9. Explain the equilibrium of monopolistic market under product variation.
10. Explain the equilibrium of monopolistic market under selling expenses.
11. How are the price and output determined in cartel?