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CHAPTER

REVENUES, PRODUCERS EQUILIBRIUM AND THE SUPPLY CURVE

Besides the demand forces, the supply forces constitute the other crucial component of market mechanism. It is the producers who supply goods and services to the market. In the last chapter we studied concepts associated with production and cost, which are relevant for producers. But we did not learn about their choice behaviour i.e. which level of output they should produce so as to maximise their profits. In this chapter we develop the revenue concepts, and, together with the cost concepts, we study profit maximisation. This, in turn, forms the basis of what is called the supply curve. Comparable to the demand curve, the supply curve shows different quantities produced and sold at different prices. In the last chapter, we saw that profits are equal to the difference between total revenues and total costs. We also discussed how total costs change with output. In this chapter, we first analyse how total revenues, defined as price output, change with output. This sets the stage for analysing profit maximisation or what is called producers equilibrium. It is an equilibrium notion in the sense that if the firm selects the level of output at which profit is maximised, it would like to stay or rest at that level of output; there is

4.1 Total Revenues 4.2 Producer's Equilibrium: The Basis of the Supply Curve 4.3 Change in Quantity Supplied Versus Change in Supply 4.4 Determinants of Supply Curves Market Supply Curve

4.5

4.6 Time Horizon 4.7 Price Elasticity of Supply

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no incentive for it to increase or decrease output from that level. 4.1 TOTAL REVENUES Unlike costs, the effect of a change in output on the total revenue of a firm depends on the market structure, which refers to the number of firms operating in an industry, the nature of competition between them and the nature of the product. In this chapter, we will consider only one kind of market structure, namely, perfect competition, which is of central importance in economic analysis. Other types of market structure will be studied in Chapter 6. 4.1.1 Perfect Competition The following six characteristics define perfect competition or a perfectly competitive market. (A) There are a large number of buyers and sellers (producers). (B) Firms sell a very homogeneous (i.e. identical) product or service. (C) There is free entry and exit. (D) Perfect knowledge. (E) Uniform price. (F) No transport and selling costs. It is hard to find markets, which exactly fit the definition of perfect competition. But the markets for goods and services like wheat, a standard hair
1

cut or a leather football can be thought of as examples of industries, which are very close to perfectly competitive markets. Because, there are typically many producers of these items. Each of these is a standardised item, i.e., naturally homogeneous. Moreover, it is relatively easy to enter or get out of these businesses.1 The implication of the product being homogeneous or identical is that all firms have to charge the same price for the product. That is because if one producer happens to charge a price higher than some other, no one will buy from the former. Why would anyone pay more for exactly the same item? Hence, all producers who operate in the market must charge the same price. Product homogeneity and the existence of a large number of firms together imply that each firm is very small compared to the whole market and no single firm can influence the market price. That is, each firm is a price taker in perfect competition.2 An example may help to better understand the price taking behaviour. Think of a product like jalebi (a sweet). If you operate a halwai (sweetmeat) shop in a big town in which there are many such halwai shops,

You can of course argue that there may be some differences between wheat produced in Punjab and wheat produced in Australia. But, for most practical purposes, the differences are negligible. Similarly, a standard haircut may differ slightly from one barber to another. But, again, it is essentially the same everywhere. The chosen examples are different from, say, the market for TVs, which are differentiated. There are black and white TVs as well as colour TVs. Even in the category of colour TVs, there are 19" TVs and 29" TVs. TVs differ not just in quality but also in style and design. This does not mean that the market price itself cannot change. How it may change will be studied in Chapter 5.

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and, the market price of jalebi per kg is Rs. 70, you will charge Rs. 70 too. Obviously, you will not charge more than Rs. 70 (and lose a lot of, possibly, all customers). There is also no reason for you to sell at any price less, because being small compared to the market, you can sell as many jalebi as you like at the going price in the market. Thus you will be a price taker. 4.1.2 Total Revenue Curve and Price Line Once you understand that each firm is a price taker and can sell as many units as it wishes at the market price, it is quite simple to relate total revenue (TR) to output.3 For example, if you sell five kilograms of jalebi, the TR is Rs. 70 5 = Rs. 350. If you sell six, it is Table 4.1 Total Revenue Schedule Output In Kg. 0 1 2 3 4 5 6 7 8 TR (Rs.) 0 70 140 210 280 350 420 490 560

Rs. 420 and so on. Table 4.1 reports the total revenue schedule for this example. 4.1.3 Total Revenue Curve and Price Line If we graph the total revenue schedule, measuring output along the x-axis and total revenue along the y-axis, we obtain the total revenue curve. This is depicted in fig. 4.1(a). At zero output, TR is obviously zero. Hence the TR curve must pass through the origin. Moreover, it is a straight line. This is because the market price is independent of how much quantity is sold by one firm. Turn to fig. 4.1(b) now. The y-axis measures price, not total revenues. Since the market price is given or exogenous to the firm, we obtain a horizontal line. This is called the price line. It is also called the demand curve facing a competitive firm in the sense that, from a firms perspective, it is able to sell to the consumers any amount it wishes at the same price. (The price elasticity of this demand curve is infinite.) There is a relationship between the price line and the total revenue. That is, the total revenue is equal to the area under the price line. This is seen in fig. 4.2, in which AB is a hypothetical price line. Suppose that the firm is producing the amount q0. Then, TR = price quantity = OA Oq0 = OADqo, which is the area under the price line.

*Market price jalebi = Rs. 70/kg

The feature (C) of perfect competition, namely, free entry and exit, does not have any direct bearing on how TR changes with respect to output. Its implication will be studied in Chapter 6.

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(a)

(b) Fig. 4.1 Total Revenue Curve and the Price Line corresponding to Table 4.1

4.1.4 Average Revenue and Marginal Revenue These are two more revenue concepts. Average Revenue (AR) is defined as revenue per unit of output. It is equal to TR/output. Note that, since TR = price output, AR is always equal to price. Marginal revenue is defined as the increase in total revenue when one extra unit is sold, i.e., it is the revenue obtained from one extra or last unit sold.4 Since a competitive firm is a price taker, if it sells one extra unit, the extra r evenue generated will be equal to whatever the price is. Thus, for a competitive firm, MR = price.5 However, the terms of AR and MR will not be used much in this chapter. But they will be in Chapter 6. Here they are introduced for the sake of completeness. 4.2 PRODUCERS EQUILIBRIUM: THE BASIS OF THE SUPPLY CURVE We are now ready to study producers equilibrium. The question is at what level of output will a firms profit be maximised? Unlike the numerical method that was used in Chapter 2 to study consumers equilibrium, we use a graphical method to answer this question. In order to do so, we need two results from our study of costs and revenues:

Fig. 4.2

Price Line and Total Revenues

4 5

This is similar to the concept of marginal utility or marginal cost. This is not true for a firm, which is not perfectly competitive.

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1. The total variable cost is equal to the area under the marginal cost curve. 2. The total revenue is equal to the area under the price line. 4.2.1 The Profit-Maximising Condition Turn now to fig. 4.3. Suppose that a competitive firm faces the market price P0, that is, P0A" is the price line. Its marginal cost curve is denoted by MC. At which level of output is the firms profit maximised? The answer is q0. In other words, we are saying that, in general, a competitive firms profit is maximised at the point where the price line intersects the MC curve, i.e., where (A) P = MC, with P denoting the market price. This is the profit maximising condition or the condition for producers equilibrium.6 Why is profit maximised where the price line intersects the MC curve? Define gross profit equal to TR TVC. By definition, this is equal to profit plus TFC. However, since TFC is constant, profit is maximised where gross profit is maximised and vice versa. We now argue that, at the market price P0, the gross profit is maximised at the output q0, where the price line P0 intersects the MC curve. We have TR = the area under the price line = 0P0Aq0, and TVC = the area under the MC curve = 0DAq0 . Thus gross profit = 0P0Aq0 0DAq0 = DP0A. Now consider any output less than q0,
6

say q'. By similar calculation, the gross profit = DP0A'B. Notice that this is less than DP0A. Look at next, a level of output greater than q0, say q". The total revenue is equal to 0P0A"q" and the total variable cost is equal to 0DCq"; thus gross profit = 0P 0 A"q" 0DCq" = DP0A ACA". This is also less than DP0A. Hence, at any level of output either less or greater than q0, the gross profit is less. This proves that gross profits, and, hence profits, are maximised at q0, where P = MC.

Fig. 4.3 Profit Maximisation

4.2.2 Rationale Behind the Condition, P = MC In Chapter 2 we saw that diminishing marginal utility is the key behind the consumers equilibrium condition of marginal utility is equal to price. In a parallel way, the key reason behind the producers equilibrium condition, P = MC, is that marginal cost be increasing with output. To see this, suppose that, starting from the level of output at which P =MC,

Observe the similarity of this condition with the condition for consumers equilibrium in Chapter 2, which stated that marginal utility be equal to price.

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the firm decides to produce one unit more. Given that MC is increasing in output, P will be now less than MC. But P and MC are respectively equal to extra revenues earned and extra costs incurred. Hence, extra revenues will be less than the extra costs, implying that the profits will be less. Similarly, suppose that the firm decides to produce one unit less than where P = MC. In this case the revenues sacrificed (equal to P) are greater than savings in costs (equal to MC). Hence, profits will also be less. In summary then, increasing or decreasing output from where P = MC results in less profits. Thus, profit is maximised where P = MC, as long as MC is increasing in output. The above discussion implies that, if at any given market price there is a level of output at which P = MC holds

but MC is decreasing, it cannot be the profit-maximising level of output. Such a possibility is shown in fig. 4.4. At price P1, the price line cuts the MC a b curve at two points, q1 and q1 , but, b a unlike at q 1 , at q 1 , MC decreases. Therefore, the profit-maximising b a output is q1 not q1 .7 The preceding analysis gives rise to an important conclusion: a competitive firm chooses an output only on the rising portion of the MC curve. 4.2.3 A More General ProfitMaximising Condition

Recall the definition of MR, the marginal revenue, and that P = MR for a competitive firm. Thus we can write (A) as MR = MC. That is, marginal revenue is equal to marginal cost. Indeed, this is a very general condition of profit-maximisation something that holds irrespective of the market structure. Having noted this, we however return to P = MC as our profit-maximising condition for a competitive firm. 4.2.4 Law of Supply and the Supply Curve The law of supply states that, other things remaining unchanged, an increase in the price of a product leads to an increase in the quantity supplied of it. It is because, higher the price, the more a producer wants to supply.

Fig. 4.4

Profit Maximising Outputs at Different Prices

a Suppose the firm is producing at q1 . If it increases output by one unit, the extra revenue generated is P1 and the extra cost incurred is equal to MC. But since MC is decreasing, P1 > MC, and thus profit is a higher. You can similarly argue that profit is less also if output is reduced by one unit from q1 . Hence, a profit is not maximised at q1 .

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Other things refer to other determinants of supply, which will be discussed later. This law, stated in a tabular form, gives rise to the supply schedule, and, the graph of a supply schedule gives the supply curve. Table 4.2 lists a supply schedule. Figure 4.5 graphs the corresponding supply curve. What is the basis of the law of supply or the supply curve? Refer back to fig. 4.4. We see that, at price P1, the b firm produces the amount q1 , at price P2, it produces q2; and so on. Hence all Table 4.2 A Supply Schedule Price (Rs.) 5 10 15 20 25 Quantity Supplied 0 7 16 28 43

price-output combinations are simply the points on the rising part of the MC curve. We can think of the output as the amount supplied to the market (assuming implicitly that the firm does not store anything beyond one period). Hence it follows that the rising portion of the MC curve is the supply curve itself ! 8 4.3 CHANGE IN QUANTITY SUPPLIED VERSUS CHANGE IN SUPPLY

The difference between these two terms is similar to the difference between a change in quantity demanded and a change in demand. A change in quantity supplied refers to a movement along a given supply curve because of a price change, whereas a change in supply means a shift of the supply curve due to a change in other factors. It is now the time to discuss these factors. 4.4 DETERMINANTS SUPPLY CURVE OF THE

Fig. 4.5 The Supply Curve for the Supply Schedule in Table 4.2

Since the supply curve is a part of the marginal cost curve, the factors that shift the marginal cost curve are the determinants of supply or the supply curve. Generally, there are two such factors, technological changes and changes in factor or input prices. Besides, in India particularly, on many industrial goods, there are taxes that are based on the total production

Strictly speaking, the supply curve is only a portion of the rising part of the MC curve. The reason for this will be covered in a higher course in micro economics.

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cost of output of a firm. These are called excise taxes or excise duties. As we will see, a change in the rate of excise duty will also shift the supply curve. There is still another factor that our simple profit-maximising analysis does not capture, namely, changes in the prices of related goods. In what follows, we consider these determinants of supply. 9 4.4.1 Technological Changes

printed pages are much less today than they were prior to 1980s. This is an example of cost-saving technological change. In the real world, there are many such examples.11 Such a technological advance lowers marginal cost at any given level of output. Table 4.3 illustrates this. Column (2) lists an old marginal cost schedule. Column (3) lists the new one after the technological change.12 Notice that each entry in Column (3) is smaller than the corresponding entry in Column (2), meaning that the marginal cost has decreased for any given level of output. The two marginal cost schedules are plotted in fig. 4.6. As we can see, the new MC curve lies below or to the right of the old one. Since the MC curve is essentially the supply curve, we have the result that a technological progress shifts the supply curve to the right. 4.4.2 Input Price Changes Changes in raw material prices, wages to workers etc. can also affect the marginal cost curve and the supply curve. Suppose you own a haircut

Science and research laboratories around the world as well as the business firms themselves look for new technology or methods that reduce costs of production. Consider for instance the printing business. In old days, bringing out a book in print was a fairly complex process.10 Now a days, with computers, word processing, spread sheet and presentation packages, all tasks except for printing are done in a computer. Changes are nearly costless to include. Using printers to print is also an easy and fairly inexpensive job. The average and marginal costs facing a commercial publisher for any given number of
9

10

11 12

There are chance factors like weather changes or health of workers, which can also shift the marginal cost curve. But we ignore them here. The supply curve is also influenced sometimes by price speculations. In times of disasters like earthquake, war, famine and cyclones, prices of essential goods typically rise. Some private producers take advantage of this situation by hoarding, that is, withholding supply of their product to the market, expecting to sell later at very high prices. We ignore these factors in this chapter. Once manuscripts of books were prepared by authors in long hand, the alphabets in the manuscripts used to be set in a frame and the frame would be mounted on a letter-press machine. The pictures and diagrams were etched on metal plates. The whole plate had to be changed if changes were to be made in the pictures or diagrams. The metal plate and the frame were mechanically inked and pressed on to paper to produce a page of the book. There is another kind of technological progress that we do not consider here, namely, development of new products. For simplicity, in both cases, the marginal cost always increases with output.

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Table 4.3 A Decrease in Marginal Costs due to Technological Change Output 0 1 2 3 4 5 Old MC (Rs.) 7 8 12 14 17 22 New MC (Rs.) 3 4 7 9 13 17

of an increase in input prices is shown in fig. 4.7.

Fig. 4.7 Increase in Input Prices and the Shift of the Supply Curve

4.4.3 Changes in the Excise Tax Rate In India, producers of various industries in the manufacturing sector pay excise taxes. As said earlier, these are taxes levied on the total production cost of a firm. Hence they add to the total variable cost. Therefore, a change in the rate of this tax affects the overall marginal cost. Suppose the rate of excise duty on a particular product increases. For any given level of output, this would increase the marginal cost and hence shift the MC curve and the supply curve to the left. Thus, an increase (a decrease) in the excise tax shifts the supply curve to the left (right). 4.4.4 Change in the Prices of Related Products Many producers, with their given amount of resources, manufacture or

Fig. 4.6 Technological Progress and Shift of the Supply Curve

saloon, employ 10 barbers and service 120 haircut jobs a day now. The hourly market wage of barbers increases for some reason. This will increase the cost of the haircut service that you provide and shift your marginal cost curve up or to the left. As a result, you will employ fewer barbers and service less number of haircuts. In general then, an increase (a decrease) in an input price shifts the supply curve to the left (right). The case

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grow more than one item. Consider a farmer who has a given amount of land, which he can use to produce wheat or corn (or both). If the market price of wheat increases, he will grow less corn even when the price of corn, the technology of producing corn and input prices (e.g. the price of corn seeds) remain the same. It is because growing corn is less profitable now, compared to growing wheat. This will shift the supply curve of corn to the left. Thus an increase (a decrease) in the price of a substitute good in production shifts the supply curve of a good to the left (right). 4.5 MARKET SUPPLY CURVE This is parallel to the market demand curve. It is derived as the horizontal summation of individual supply curves. In Chapter 2 the market demand schedule was obtained by numerically adding up individual demand schedules. Here, the market supply curve is derived in an equivalent, geometric way (so that you get to know both ways).

Assume that there are two firms in an industry, A and B. In fig. 4.8 the curves SA, SB and SA+B respectively denote As supply curve, Bs supply curve and the market supply curve. For example, at price P1 the producer A supplies A1 units and the producer B supplies B1 units. The total quantity supplied to the market is then A1 + B1, shown along the SA+B curve against this price. Similarly at P2, the total quantity supplied is A2 + B2, where A2 and B2 are quantities supplied by producers (firms) A and B respectively. All other points on the market supply curve are derived in the same manner. Note that a market supply curve is derived on the assumption of a given number of firms (100, 200 or whatever it may be). Hence, apart from any factor, like a technological change or a change in any input price, that shifts the individual supply curve and thereby the market supply curve, the latter also shifts when the number of firms changes. An increase (a decrease) in the number of firms shifts the market supply curve to the right (left).

Fig. 4.8

Individual Supply Curves and the Market Supply Curve

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When there is an increase (a decrease) in the number of firms, we say that there is more (less) competition in the market. Thus, we can also say that more (less) competition shifts the market supply curve to the right (left).13 4.6 TIME HORIZON An element of time lies behind the supply curve being upward sloping. Suppose that you manufacture chewing gum. The market price that has been prevailing for a long time is one rupee a piece. At this price, you were producing 1 lakh chewing gums per month. Now suppose the price increases to two rupees a piece. This is good news for you. As a rational producer, you would want to produce more by hiring more workers, more chemical engineers, more equipment etc. This will mean that your supply curve is upward sloping. However, it takes time to hire people, get new machinery etc. Within a very short period, you cannot make these changes. Your production level in a very short period of time is given, irrespective of whether the price may have changed to Rs. 2, Rs. 3 or Rs. 1.50. The resulting supply curve will be a vertical line, as shown in fig. 4.9. Such a short period
13

is called the market period in economics. By definition, it is that short a period within which firms cannot adjust their output to any change in price. As a result, the supply curve of a firm or the whole industry is vertical. In a longer run i.e. in the short run or long run the supply curve will be upward sloping, as drawn earlier, because inputs can be changed.

Fig. 4.9 Supply Curve in the Market Period

4.7 PRICE ELASTICITY OF SUPPLY 4.7.1 Definition and the Percentage Method of Measurement Parallel to price elasticity of demand, the price elasticity of supply quantifies the responsiveness of quantity supplied to changes in price. It is defined as (B) Price elasticity of supply = es

As you know, India has been following a path of economic liberalisation, especially since the 1990s. Many foreign firms that couldnt earlier enter the Indian market in different sectors can and do so now. Thus liberalisation brings forth more competition. The Indian automobile market is a prime example of this. Until the seventies, in the passenger car market there were only two companies that were allowed to operate: Hindustan motors (with Ambassador) and Fiat (with Premier Padmini). In the 1980s came Maruti, which is owned jointly by the Indian government and Suzuki Motor Corporation of Japan. In the 1990s, many foreign companies started to produce and sell such as Daewoo of South Korea (Cielo), Hyundai of South Korea (Santro), Honda of Japan (Honda City) etc. Even Telco, an Indian Company, which earlier produced only trucks and buses, entered into the production of small sized cars (Indica).

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% change in the quantity supplied % change in the price

On a given supply curve, let P0 and S 0 denote the original price and quantity. If the price rises to P1 and quantity supplied increases to S1, the % changes in price and quantity supplied are respectively [(P1 P0 )/P0] 100 and [(S1 S0 )/S0] 100. Hence

S0 = 5,000, P1 = Rs. 10 and S1 = 8,000. Thus,

[(P 1 P ) / P ] 100 0 0 [(10 8) / 8] 100 25,

and

[(S1 S 0 ) / S 0 ] 100 = [(8000 5000)]/ 5000] 100 = 60.

Hence, eS 60 / 25 2.4. Just as in case of price elasticity of demand, (a) the price elasticity of supply is independent of units, and (b), if two supply curves intersect, the flatter one has higher price elasticity at the point of intersection. The reasons are exactly parallel what they were in case of price elasticity of demand. 4.7.2 The Geometric Method Also similar to point elasticity of demand, for very small price changes, the price elasticity of supply can be measured by a convenient geometric formula. Refer to fig. 4.10. It shows three straight line supply curves. Panel (a) illustrates one, in which the supply curve, extended towards the x-axis, intersects the x-axis in its negative

(S S 0 ) / S 0 S / S 0 = (C ) es = 1 , (P1 P0 ) / P0 P / P0
where denotes the change. If the supply curve is vertical, then the price elasticity of supply is, obviously, zero. Otherwise, given that the supply curve is positively sloped, the price elasticity is positive. As a numerical example, suppose that you manufacture one type of ballpoint pens. When they were selling at the price Rs. 8, you produced and sold 5,000 pens a month. Now its market price has increased to Rs. 10 and you are producing and selling 8,000 pens a month. In this example, P0 = Rs. 8,

(a) Fig. 4.10

(b)

(c)

Price Elasticity associated with Straight Line Supply Curves

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range at point B. In fig. 4.10(b), the supply curve intersects the x-axis in its positive range. Finally, in fig. 4.10(c), the point of intersection is the origin; that is, the straight line supply curve passes through the origin. In all panels, P0 is the original price, 0C is the quantity supplied and A is the point on the supply curve. It turns out that the point elasticity is equal to the horizontal segment BC divided by the quantity supplied 0C, that is, BC/0C. 14 (Ignore for the moment fig. 4.1.(c) in which there is no point B.)

Thus, along the supply curve in panel (a), the price elasticity is greater than one (as BC > 0C). By the same argument, along the supply curve in panel (b), it is less than one (as BC < 0C). Finally, in panel (C), you can say that the point B is same as the origin. Thus BC = 0C implying e s=1. That is, any straight line supply curve passing through the origin, irrespective of how steep or flat it is, implies price elasticity of supply equal to one.

CLIP 4-1
Does computerisation reduce employment? This is a sensitive issue for a populous country like India. The traditional thinking is that computerisation or for that matter, any technical improvement that is labour-saving is or must be bad for employment. If you replace a person with a machine, how could it not reduce employment? This is, however, a narrow point of view, having two major flaws. First, it has a very short run perspective, and second, it presumes that those who are replaced by computers or machines do not have or are incapable of developing any other skills and hence must remain unemployed for a long time. Yes, at the time when a machine is replacing a person or many persons, it has a negative effect on employment. But this is hardly the end of the story. A firm is doing it in order to save costs. As the total variable cost curve shifts down, so does the marginal cost curve. This means that the supply curve will shift out and more will be produced in the new equilibrium. From the whole economys perspective, the production possibility curve (see Chapter 1) shifts out. Higher output would require more employment of workers, both skilled and unskilled. Also, computerisation by itself creates demand for new types of jobs. Hence there is little reason to believe that computerisation will reduce employment in the long run. On the other hand, it leads to a greater productivity of workers and higher wages. The negative effects of computerisation are present only in the short run. A traditional typist who is replaced by a computer can learn word processing and possibly land a more paying job. Of course, computerisation or mechanisation may, for example, take away the job of artisans, who with their own bare hands, make beautiful handicrafts. On the other hand, expansion of the small-scale
14

The proof of this is beyond our scope.

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industries due to computerisation will lead to more employment. In the worst case, one type of job is replaced by other type of job: the workers who lose their jobs and cannot change their skills may not get their jobs back, but other category of workers will now find jobs. In summary, there may be employment costs of computerisation, but only in the short run. On the other hand, there are major long-run benefits.

SUMMARY
l l l l l l l l l l l l l

The total revenue curve facing a competitive firm is a straight line passing through the origin. The price line facing a competitive firm is horizontal because this firm is a price taker. The price line is also interpreted as the demand curve facing a competitive firm. A perfectly competitive firm maximises profits, i.e., attains producers equilibrium, when price is equal to the marginal cost. In general, a firms profit maximising condition is that marginal revenue is equal to marginal cost. The profit-maximising condition, price is equal to marginal cost, forms the basis of the supply curve. Increasing marginal cost explains the law of supply or why the supply curve is upward sloping. A firms supply curve consists of the rising portion of its marginal cost curve. A cost saving technological progress shifts the marginal cost curve down and hence shifts the supply curve to the right. An increase in input prices shifts the marginal cost curve up and hence shifts the supply curve to the left. An increase in the rate of the excise duty shifts the supply curve to the left. An increase in the price of a substitute good in production shifts the supply curve of the product in question to the left. Market supply curve is obtained by horizontally summing up the individual supply curves.

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An increase in the number of firms shifts the market supply curve to the right. During the market period, the individual and the industry supply curves are vertical. Price elasticity of supply measures the responsiveness of quantity supplied to a change in its own price. A straight line supply curve which intersects the x-axis in its negative range implies price elasticity of supply greater than one. A straight line supply curve which intersects the x-axis in its positive range implies price elasticity of supply less than one. A straight line supply curve passing through the origin implies price elasticity equal to one, irrespective how steep or flat it is.

EXERCISES

Section I
4.1 4.2 4.3 4.4 4.5 4.6 4.7 4.8 4.9 4.10 What is meant by producers equilibrium? What is the relationship between total revenue, price and quantity sold? What is the relationship between price and marginal revenue for a competitive firm? What is the condition of producers equilibrium for a competitive firm? What is the condition of profit maximisation for a competitive firm? What is the general profit maximising condition of a firm? What is meant by the Law of Supply? What is meant by a change in the quantity supplied? What is meant by a change in supply? Due to improvement of technology, the marginal costs of production of televisions have gone down. How will it affect the supply curve of television? What effect does a cost saving technical progress have on the supply curve? What effect does an increase in input price have on the supply curve? What effect does an increase in excise tax rate have on the supply curve of the product?

4.11 4.12 4.13

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4.14 4.15 4.16 4.17 4.18 4.19

If a farmer grows rice and wheat, how will an increase in the price of wheat affect the supply curve of rice? What is meant by market period? How will an increase in the number of firms shift the market supply curve? What does price elasticity of supply measure or quantify? If two supply curves intersect, which one does have higher price elasticity? What is the price elasticity associated with a straight line supply curve passing through the origin?

Section II
4.20 4.21 4.22 4.23 Why is the total revenue curve facing a competitive firm a straight line passing through the origin? What factors determine the market structure? What are the features of perfect competition? What is meant by a product being perfectly homogeneous? What is its implication for the price charged by producers in the market? Briefly explain why a perfectly competitive firm is price-taker in the market. A perfectly competitive firm faces market price equal to Rs. 15. (a) Derive its total revenue schedule for the range of output from 0 to 10 units. (b) Suppose the market price increases to Rs. 17. Will the new TR curve be flatter or steeper? Complete the following table when each unit of a commodity can be sold at Rs. 5. Quantity Sold 1 2 3 4 5 6 7 TR MR AR

4.24 4.25

4.26

REVENUES, PRODUCER'S EQUILIBRIUM

AND THE

SUPPLY CURVE

83

4.27

A firms TR schedule is given in the following table. What is the product price facing the firm? Output 1 2 3 4 5 TR (Rs.) 7 14 21 28 35

4.28 4.29 4.30 4.31 4.32 4.33 4.34

4.35

4.36

Why is AR always equal to MR for a competitive firm? Name three factors that can shift a supply curve. Give two examples where technological progress leads to a shift in the supply curve. How does a change in the price of inputs affect the supply curve of a commodity and why? How does an increase in the rate of excise tax shift the supply curve and why? How does a cost saving technological progress shift the supply curve and why? A new technique of production reduces the marginal cost of producing stainless steel. How will this affect the supply curve of stainless steel utensils? Because of cyclone in a coastal area, the sea level, covers a lot of rice fields. This reduces the productivity of land. How will it affect the supply curve of rice of that region? Consider the following individual and market supply schedules. Price (in Rs./kg.) 1 2 3 4 5 Firm A (kg.) 37 40 44 48 Firm B (kg.) 20 30 50 60 Firm C (kg.) 45 50 55 65 Market (kg.) 100 135 154

84

INTRODUCTORY MICROECONOMICS

(a)

4.37

Complete the above table on quantities of potatoes supplied by the firms and the market. (b) Plot the supply curve of each firm and the market supply curve in a single diagram. What relationship do you observe between the individual supply curves and the market supply curve? (c) Calculate the price elasticity of supply of Firm A when price rises from Rs. 2 to Rs. 3. Draw straight line supply curves with (a) unitary price elasticity and (b) zero price elasticity.

4.38

The above diagram shows the supply curve of 3 commodities. Rank their price elasticities.

Section III
4.39 Show that the rising portion of the marginal cost curve is the supply curve of a competitive firm.