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Theory of the Firm
Total Revenue = The total amount received from selling a given output
...

AR = TR / Q
Marginal Revenue = The amount received from selling one extra unit of output
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TC = FC + VC
Fixed Costs - Do NOT vary with output, e
...
Rent, Insurance
...
g
...

Semi-Fixed Costs - May vary with output but not directly, e
...
energy costs
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AC = TC / Q
AVC = TVC / Q
AFC = TVC / Q
Marginal Cost = The cost of producing on extra or one less unit of output
MC = TCn - TCn-1
Profit = The difference between Total Revenue and Total Cost
π = TR - TC
 The reward for enterprise
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 Relating price to costs helps a firm to assess profitability in production
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 Cost of exit may be high
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Profit Maximisation is when MC=MR
Optimum Level of Output - the output where ATC is at its lowest point
...
In the short run, a firm will not operate beyond this
point, however in the long run they will have to invest in capital, e
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a new factory, in order to
expand output efficiently
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Long Run - all capital factors can be increased and average costs have been minimised
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Occur
due to specialisation through increased division of labour
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Purchasing Economies - bulk buying discounts
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Diseconomies of Scale - a firm’s average costs of production start to rise as its output levels get too
large
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 Less dynamic and more bureaucratic
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Internal Economies/Diseconomies occur as a result of the growth in output of the firm
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Efficiency
Productive Efficiency occurs within a firm when output occurs at the minimum average cost- AC is
minimised
...
e
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AR = MC
Both of the conditions for efficiency are achieved in the market ideal of Perfect Competition
...
e
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X-Inefficiency occurs when a firm's actual average cost is higher than its potential average cost
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 No influence on price
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 Infinite buyers and sellers
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 AC is minimised - Productive Efficiency
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 P=MC - Allocative efficiency achieved
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 Market Power
Outcomes:
 For the Monopolist, AC ...

 Economically speaking, AC are not minimised and so not productively efficient and Price>MC
which is not allocatively efficient
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 Higher employment opportunities depends on types of production methods researched
...
Firms will wish to enter a market if there are abnormal profits in industry
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 Legal Barriers exist because there may be patents, copyright and trademarks though when
the biro was introduced in 1947 the existence of such barriers failed to prevent new firms
entering
...
g
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 Cost Barriers
o Absolute Cost Barriers refer to the fact that enormous sums of money are needed to
enter some industries, e
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a nuclear power station costs around £15bn to build
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Firms who have
to pay entry fees, e
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licence costs or firms which require vast marketing will not be
able to retrieve these costs if forced to leave the industry
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o Relative Cost Barriers relate to the fact that ‘new’ firms have high set up costs and
their average costs will therefore be higher than firms already in the industry
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 Behavioural Barriers occur when firms already in an industry behave in a way to put off new
entrants
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g
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They may jointly market their firms to create big
competition for new entrants, airlines codeshare on flights sold
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Monopolistic Competition
Characteristics:
 Large number of small firms
 Price makers
 Firms able to produce a slightly differentiated product
 No or few barriers to entry
 Short run abnormal profits competed away by new entrants
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 Small market share and lots of firms supplying
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 Some Market Power (ability to set price) depending on brand strength
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Oligopoly
Assumptions and Characteristics:
 Small number of very large firms - dominate market share
 Barriers to entry

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Similar but slightly differentiated product-branding
Firms are interdependent - they match price reductions but not price rises
Monopoly profits and inefficiency

Motives of a Firm
 Profit Maximisation
o Assumed to be the standard motive of firms in the private sector
o Profit maximisation occurs where MC=MR
o The firms will continue to increase output up to the point where the cost of
producing one extra unit of output=the revenue received from selling that last unit
of output
o This assumes that firms seek to operate at maximum efficiency
 Sales Maximisation
o Attempts to maximise the volume of sales rather than the revenue gained from
them
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Title: Theory of the Firm
Description: A2 Economics describing the basis for the entire Micro course - profits, costs, perfect competition, monopolies etc. I have not included the relative diagrams but my email is cerysannmay1@gmail.com and I can scan those in and send them your way for free. Thank you!

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