HWA CHONG INSTITUTION

Year Two H2 Economics 2013

Tutorial #23: Microeconomics III Theory of the Firm & Market Structure

TUTORIAL #23: THEORY OF THE FIRM & MARKET STRUCTURE

Suggested answers to BEE questions

Pg 23.2.12
Q1: Explain and illustrate with a revenue-cost diagram how a firms supernormal profits shrink
but still earning supernormal profits when demand falls.
Figure 1: A decrease in supernormal profits (still > 0) when demand falls
Price/Revenue/Cost ($)

P0

P1
C1
C0

MC

AC

X
Y
B

MR1 MR0
0

From Figure 1, a fall in demand

will cause AR0 and MR0 to
decrease to AR1 and MR1
respectively. These resulted in
lower output from Q0 to Q1,
lower price from P0 to P1 and
unit cost rises from C0 to C1.
Supernormal profit decreases
from P0C0BA to P1C1YX.

AR1

AR0
Output

Q1 Q0

Hwa Chong Institution. All Rights Reserved. Tutors' Copy

HWA CHONG INSTITUTION

Year Two H2 Economics 2013
Tutorial #23: Microeconomics III Theory of the Firm & Market Structure

Q2: Explain and illustrate with a revenue-cost diagram how a firms supernormal profits shrink
and make a loss when demand falls.
Figure 2: Making losses/subnormal profits when demand falls
Price/Revenue/Cost ($)

P0

C1

P1

C0

MC

From Figure 2, a fall in demand will

cause AR0 and MR0 to decrease to AR1
and MR1 respectively. These resulted in
lower output from Q0 to Q1, lower
price from P0 to P1 and unit cost rises
from C0 to C1. Supernormal profit
decreases from P0C0BA to subnormal
profits of C1P1YX.

AC

MR0
MR1
0

Q1

AR1
Q0

AR0
Output

Hwa Chong Institution. All Rights Reserved. Tutors' Copy

HWA CHONG INSTITUTION

Year Two H2 Economics 2013
Tutorial #23: Microeconomics III Theory of the Firm & Market Structure

Pg 23.2.13
Explain and illustrate with a revenue-cost diagram how a firms supernormal profits shrink and
make a loss when fixed costs increase.
Figure 3: A fall in supernormal profits till making losses when fixed cost increases
Price/Revenue/Cost ($)
MC0

C1

P0

C0

AC0

MR
0

Q0

AC1

From Figure 3, a rise in fixed

cost will cause average costs to
increase from AC0 to AC1. MC
and MR do not change when
only fixed costs change, MC
cuts MR at the same point and
equilibrium output and price
remain the same at Q0 and P0.
But profits have shrunk from
P0C0AB to losses C1P0BX.

AR
Output

Hwa Chong Institution. All Rights Reserved. Tutors' Copy

HWA CHONG INSTITUTION

Year Two H2 Economics 2013
Tutorial #23: Microeconomics III Theory of the Firm & Market Structure

Pg 23.2.14
Explain and illustrate with a revenue-cost diagram how a firms supernormal profits increase
when the firms variable costs fall due to a rise in productivity.
Figure 4: A rise in supernormal profits when variable cost decreases
Price/Revenue/Cost ($)

MC0
P0

P1

C0

MC1

AC1

C1

Y
MR

AC0

From Figure 4, we can see that a fall

in variable costs will decrease
average costs from AC0 to AC1 and
marginal costs from MC0 to MC1.
These resulted in higher output from
Q0 to Q1, lower price from P0 to P1
and unit cost decreases from C0 to
C1. Profit increases from P 0C0BA to
P1C1YX.
Consumer
surplus
increases by P0P1XA

Q0 Q 1

AR
Output

Hwa Chong Institution. All Rights Reserved. Tutors' Copy