472 . .. .

Managerial~
'equitable'. The maximisation of total economic ·surplus does not capture the equity~
social welfare. In the light of this fact,· the total economic surplus (i.e.'. the sum of pr~
surplus and economic surplus) is not a very good . measure of social well-beir:ig. 1n .
maximisation of total surplus leads to the outcome which is economically efficient but it
not. be necessarily fair or equitable. . , j : l . • ' ' '-· • I , 1 ; • · : '
1 •
1
•
n:;
. It may be noted that some economists consider rri~sati~n _of to!31 surplus as a valid
~nterion of social welfare as they think that once total surpl~ IS maximised, ,!t can be redistributed
m accordance with society's notion of equity or fairness. It 1s argued that , make the pie as bi
as possible and then distribute it according to society's notion of equity. :• However, In~
view, it is difficult to redistribute o~tput and income so as to ensure equity and .thereby to
increase social well-being: Besides, in the redistribution, demand and supply curves of a 900d
which generated the maximum total surplus, are likely to change which may result in deviation
of the outcome from the maximum total economic surplus (or economic efficiency). ~
FNlfMERiCALPROB~'ioi~i]:>ERFEcft'coMPEffnmfMOD
Let us solve some numerical problems to make clear the conditions of profit Il)clXimisation
under perfect competition. . , · , • · . ··
· . Problem 1. For a perfectly ·competitive firm, the following
. short-run'
Junction
.
Is
given · · · , . , · , ·, '., ·· · 1
· •• • •·. ·
• • ••

' TC = 2 + 4Q + 02 1' ' ' . '· I

If price of the product prevailing in the market is Rs. 8, at what level ofoutput the
firm will maximise pro/its ? ,. , ,· · ·
, ·, Solution. Since total revenue is price multiplied by quantity ·of output, .total revenue
function is ' · ~- ~·. · ·,· .,..'. :. :,. ·.· · ....
,, . ►
· ·I , TR= P. o =·so-·· ...· · -.;
, ·' , · . TC = 2 + 4Q + Q2 · ·· : ::
We explain below the profit maximisation with both the TR - TC approach and
MC-MR approach, .. . :. _,. :· , =· .•.. :,.:, ~ i J ~ • .'. , •. , , ,

,- -TR- TC Approach ,. , · .. ,1•. ·/,:.~r ·,,, ··!. ! · .• ...

·.. , , Profits ·. :. 1. • , , J , · '· , 7t =·TR--; TC . ,.. · . .• . , : -: .
I\' '' I • ' \ '' • • ~. • : • ; '
, , .. •= SQ - (2 + 4Q + n'J.)
•1 •
1 ." ,• ' _ l... '' •• i ...) • • •' ••• ' ~ . , ., •• , •
0

,. ' ·' ' l., I •• ; i , 1:-- = BQ - 2 - 4Q - Q2 . . ,. I ; ;•. • • •• ' : ' I • ~. -,

I ,_ •,·, I ;•• '

1
. , . , : '1 I• I • '• ='4Q-2-Q2 r;: I '• • • • '. ' • • ,:,(0
. ',. Now,' profits will be maximum at the 'output le~el at which first derivative of profiflunctton
with respect to the quantity ·of 'output eq~ 0. 'Thus; by taking the first derivative of profit
function (i)' and setting it equal to zero;·we. have .=- ' 1..- _,. • • • . · ·• · · •
I • • •• : l ! ... ,.:: : '1. 'J - ' • ' .. I • j ~ I • I • • ,l ,I· l I'

·1• • , · ·1 ·• 1!. .,,,·. d1t · - , ,Q ·.- .· . ,; . j r l ·

. .' ' I ; I • •' I '. ' • ., ', 'dQ .=
4 .-: 2 := 0
:: ..., ' \.I, • j ' ' ' • • • ' : ' I • \ ' I ~

' ' .
. . .. 2Q=4 .
'
I• • i ,•:••
t
' , •:~ I •
o• '•,'2
= • i \l'\;
•, .., ,,,: .. • ' ...,,., '• ;,r,~ l •
j ~

I• :•t ( 1 + I• t I• \ I I - • I \ ! t I I ' . ~ : ' • ~ ' ,• • ,. • ' : ) r (' I ' . • ,. ~I •• I f'

. . . .MR-MC Approach . , .... , , . . , _ , · · ·' · · ·· ,·
·: In,this .~pproa~fr profits are ~W)l -~t th~ ou;uf le~ei' at ~hich equals MC, we
• ,.
1

MR'
therefo~e ~ derive .~e !!larginal r~enu~ and ~arginal cost' from TR and TC ~cti~::.(IO
,;_..,, '·..l,,,~··· ~·,.•;·TR - BQ ! !l .. • .
J~ . ,, -~
... • : • • .. , ;. : . :, ·· • . • ~
• • ~I
O
I l )• ; l •

··:,
' .
~ > :.. ~- .:.i....
1 'I
• . ' , . ' ,. •• • '·

' .. , '
. ,,..
.,
0
1,. l ~) ~ i >t • t \ ,
.
~res and Price and Output Determination Under Perfect Competition 473
p:-:,
..
, ' ..· TC'
2 + 4Q + Q2 . == .. .(iii)
l . •I ·, ' I d (TR) ' '
' I

, , , · MC = dQ = 4 + 2Q l .

In order to determine profit-maxi~ising output we set MR equal to MC. Thus,

. ·- ' MR= MC .
8 = 4 + 2Q
2Q = 8 - 4 = 4 · . ·
'
• J,J I •
o· = 2.
Problem 2. In a city there are· a 'iarge number of firms selling a product and no
sfnglefirm has any control over the price of the product. The following total revenue and
~t functions are given for a single seller . ,·
TR =l0Q
.TC= 1090 + 2Q + 0.0lQ2
Determine how many units of the product a firm will produce per annum if it aims
~ pro/i_t maximisation. A-,so find out the total pr~fits made by it in the equilibrium
situation. . , · _
· Solution. We determine -MR and MC form the given revenue and cost functions. Thus,
· TR ·= l0Q 1
• •

: ' 1 , o • ~• • I • • • - f..

.- ~ d(TR) I .

MR ,=_ ·. dQ 1 :=.10
• I

· ' (Note that since MR is const~nt, price will be equal to it.)

TC= 1000 + 2Q + 0.01Q2
. .'
, .d (TC) ~-' ' .
M~ = dQ = 2 + 9.02Q
For profit maximisation . '. I'• I I,

• I
MC=MR
2 + 0.02Q.,;; 10
0.02Q = 8 .,
, ._ _8 X 100 .;,_
Q- 2 .400 .
Profits
=TR-:- TC ~ 1t
TR= P.Q = 10 x 400 = 4000
.TC= 1000 + 2 x 400 +0.01 (400)2
= 1800 +· 1600 = 3,400
. 1t = 4000 - 3400 = Rs 600 · ,.
""- ~oblem 3. A firm producing bread is operating in a perfectly competitive market.
•11e /1rn,' . b
s variable cost function is given Y
,
!alien • . •. TVC = 150Q - 20Q2 + Q3
.1 • ' • I I . • •
'
I
I

· e Q is level of output.
 . ' ,
474 • : 'I • . • ,I • • , •• ,,~ :, ,•~ •: ~

,. Determine below what price the firm should shut down production in the h ~
'f S Ort
Sol ti In the short run a firm will s~ut down operations i the Price falls !'!in,
level of ;in: ~
average variable cost. So w~ first determine the minimum avera ~~'
9
cost. .. ·. . . . .. . , ., ,. ·. · ~
';. .. 7VC 1500 2002 03 ' -, ·
AVC= (J.= ,· O - O + 0
2
AVC -= i50 - 200 + 0
· To determine the level of output at which average variable cost is minimum
first derivative of the AVC function and set it equal to zero. . . .
' • • I ,
.' ,~ . . , ~e take~ I •\ • • • r

..
~ ~ 20 + 2Q = (}
\

d(;~ , ·,·

20 = 20
,. Q= 10
. · Now, substituting the valve of Qin the· AVC function we know the ,minimum a
variable cost. •, • ",• ·· · · ,. · . ; ·,, ·1. ·;
AVC = 150 - 20 x 10 + (10) 2
.,; •=150-200+100=50 •,,:
I ,·,1 ,f''. '!;:·,
· Thus, if price falls below Rs. 50 per unit the firm will shut down.
Problem 4. A firm's total variable cost is given by the following:
TVC ::·7sQ- lOQ2 + Q3
. Will the firm produce the product if price of 'the product is Rs. 40 ?
Solution. A firm produces a product if price of the product exceeds its minimum a
variable cost '' ' I ' ' ; • .. ' ' . " . • . .. r, ' • ' 'I ! .•
I, . I ' ) ' •' ··, ·• ·' ' . .. • I

JVC = 75Q - 10Q2 + Q3 AVC =

,-.Q
I ,/ I Q I . I

= 1s·-10O + 02
AVC is minimised at the output level at which I • '
J. I

d (AVC) . :-
dQ ' =Q, ' : '
Taking the derivative of AVC we have: ·. '
'
d (AVC) = .:.. 10 + 2Q
dQ .,
Therefore, AVC will be minimum when
... 'I

-10 + 2Q;.,, 0
,. · . : ~ 2Q = 10
,, I •11 .: I
,.
I

,•.••t:(JII '/•
· . 10 ' 1
'! , I ,,
•
I 'l Q = - 2 , -- 5
• I

Now substitu~g the value' of Q in equation for ·AVC we have

· · · · ··.. Minimum AVC = 75-10 x 5 + 25 -i: , , . •· :'. ,,: ').,
= 100 ._ 50 = 50·,,. ~.• . ,·. i:-:- ,·· ,• -·~
Thus, price of Rs. 40 of the product is 1 · th • th. . . vanable '
firm will not produce the product. ess an e mlfllmum averafe . , , 1 1 : : ·
j. $\ 1 . ; ': ·1 ' ·' ~ .
 Ill'!!! ~res and Price and O ut Determination Under Perfect Com ltlon . 475
p,oblern 5. Given. the follow
. ing short-
.
1 1·rm
run cost Junctlo noai
' •• "
1
• • TC = 1000 + ·10Q2 · , • ·, I f

[)eriue the expres sion for firm's short~r'un supply ~urve.

firm's short-run supply curve is firm's short-run marginal cost curve. 1io
. al A t f ti0
Solution: ,,· ,
obtain margin cos unc ~ we have to obtain the first derivative of total cost function.
Th~, .
T • •
JI ' (

dTo·, - - · , ,·. · ..
MC = dQ = 2 x l0Q = 20Q.
I •,

To get the short-run supply curve of a firm ·w~ ~t pri~e. equal to marginal cost. Thus,
P = 200 ·· .
(
p .
or . Q =, 20 '' •' , • ( ., ,) •
. ,l
•
•
•••
• ' . . . .. (1)
~ I i t ' f~

the
. Since the supply curve o{ a fi~m is that pqrtion of marginal cost curve that lies above
t level
minimum point of the average variable cost (AVC) curve. AVC is minimised at the outpu
where its first derivative equals zero. From the given cost function we find that
TFC = 1000
and 1VC i~ 10~ . : . .' - . ·. , : ' . 2 l I ' ' ' , I l • .• I : • ' . • J ; ( \

AVC =;_,TVC = lOQ = lOQ ' ' I , ' ·•

Q . ) Oi . _ ,.
. ; ~tting its derivative equal to zero we haye - . , ; . 1
•,
1

·; , ; . ; rI · r • ~ • • '! · . ' d(l OQ) ~ _. () · ,

dQ
or Q _=: 0 ,. ., · .
r . -- -·.r ' :r , -
that the
Thus, AVC is minimised when output (Q) is equal to zero. It therefore follows
the short-
entire supply function found in (1) above,,t namel\y, Q = P/20 or P = 20Q represents ,I I ' ' • •
•

run supply curve of the firm. .. , .-., .. -· . , . .. l

4i ' 1• • • -

with a
Problem 6 . A firm opera ting in a purely compe titive enviro nment is faced
functi on
market price of Rs. 250 per unit of the product. ·The firm's total short-run cost
is• · - ~ .,. t J, ,\ 1 ·
I '!I '- ... 1..

= 6000 + 400Q - 2002 + Q3

u\ I I , O

I I
~ .. · - - TC

(i) Shoul d the firm produ c~ at this price in the short-run?

{ii) If the marke t pri~~ is_f?s. 30p per unit, what will total profits (losses)
be if the
firm produ ces ten units of outpu t? Shoul d the firm produ ce at this price?
· · (iii) If the marke t price is greate r than Rs. ,300, should the firm
produ ce a_t this
price? .·. ,
Soluti~n. (i) A firm will continue producing in th~ sh~rt run if price of the product of
Rs.
minimum
250 exceeds the minimum average yaria~le co~t. So, ~e have first to find out the
aVerage variable cost. 1
• ,_ 1 • , ( '.'' • .:~ . • _ •

does not
Note that in the given cost function Rs. 6,000 _is the total fixed cost because it
~~ any output eleme nt (Q). Thus,. I ' ' . . , ~ :~~ ·, · ' • ' I '/ . • i! . ~
• ' · ., -
1
• TVC ·= 400Q -20'- ' .+i~ :, ·:.: , . ~· · . ' J,

1VC :- · 400Q -20Q2 +Q3 ' 1

• •• - '.' •• _, - :

'..
-~' ••• •
·., , :

. ..
.• , _··. , ~~~. -

·o- . ·-
: • ,. J ,•, :-;-,

·_ . ,. -.... _. o -·• ,
•• •
AVC=-=----- ·• 1 .,
 . , , •· · •1 ' · • Manager1a1
476
AVC = 400 :-; 20Q + Q~·. . · i, .. •.:·, ~: ~
1
· · · · · f' · tp t at which average variable cost is minimum
To determine the leve1o ou u · · ' We fake
first derivative of AVC function and.se~ it equ~ ,t? z~ro. , · ~ · .1 • , 1 • -,.. • , the
1 , • t \ l 1~

. . d(A \/1C) . ... •', ' ' ' 'Q- . ' ' I .,
' . 1 ~ •• ,
. '1
I • : ; •••• ' ' •

' I
J I . _.:...-- = 7, 20 + 2 l ' , I .- !. ,f ' ' -
t • ·:1 ·, dQ •· ' ..•.
''·

d(AVC) = 0 w~ have
Setting 1
,dQ
' 1'

.; -20 + 2Q f •
=, 0 I ,
..
• I .' o• .,: • \ • • JI
I 'I'
I
'' 20 = 20 .
Q= 10 ,.
: : · Substituting the value of Q in the AVC fun~tion' we have
2
.;. ,, , . MinimumAVC =:= 400 ,-20 x 10 + (10) .=.300 , . /': •. , ., _ 1

· . . ·: Since the price of Rs. 250 is than th~ minimum average variable cost of Rs. 300 the iess
firm will not produce in the short run because it will not even recover variable costs; '
(ii) If the market price of the product is -~ · 300,· it ~~y contin~e prodJc~ g in the~
run because it will be covering the variable coJts fully, ¢<?ugh it will not be recovering any part
of the fixed costs and therefore suffering losses. .
It should be noted that at price Rs. 300, the firm shall produce 10 units.: This can oo
known by equating this price with marginal cost. ,which is the profit-maximising condition
1
under perfect competition. Thus, ' •• - , ;,· - ·
1

I
I I

,,
I
..... "
J •
.. '
.. r •

Now ATC = 6000 + 400Q- 2002 + Q3

I· ... . ' I ;

. I Q
.. . I 1 I
• ' 1 ·
•
'. I
'
· •·, · r . ) • , .. t• I
,
:
I t -1 :
l .. :· I 'J
.\ '
' I
'- .
6000- · 4. • · . • \ ' • ~ ~1
• •, '
1
', I ' 1I \

~ l Q ;· ~;~Ot • • • • ·\ ; ·, I ' '~ : ·, t .. q?~ ?,,_'

2
, ,.'!
t '.1
,._,1:~ {,: \
I1 • • .

· · ·'· ATC at output 10= ·600 + 400' _ 200'·+ 100 = , .; • • ' I

900
Losses at Price Rs 300 :
I
•
;1
• I
.
l:'. ' 7t =· -r
,R-Tr- ,.• ' . "'> • • • '.':
,, .• /I , .f
• ; I <tt 1 ,; I •J ,,_• ,• 1\..,, ... ,~ I • f

x
-..J

· TR -~ P · Q ~ ATC Q . ~ .. ,i .... , • , •

;,.,•--,·,, ., .. , ,,. . ,"'.'(300xl0) 7 (900xl0) :·,-: ... ·-·,.

' • ,o • lj I = 3ooo ~ 9000 ~ .!.. 6000 • • ('. •' _' I,; ' l I • • iS, •
Thus, the firm will be suffering losses e ual - '. ;· r . : . • unit (wat :
losses are equal to the total fixed cost).- . ~ , . t~ ~ -~:9~0 at_pnce Rs
r

per ~'
1
I.

3?0
Problem 7 : Suppose a firm is O e . - ditloflS :
the market. It faces the following rating, perfectly competitive con ; reJ und.er
"' 0
nue ~.d cost conditions: • . j
 ~ and Price and Output Determination Under Perfect Competition 47"'"
V
• ~ _.: •·,.TR=
.~ . · £ . . . { ' .... '. ' . .- ' TC
·. ·l2Q. :
,,.:, .' .
~ . , ,. - . • ,-....
.·'
1
1,
• I I'• ' ' •. \ ' ·, \ I • '

:a 2 +· 4Q -f- Q2 ' · i; ' • I - r " / •

I •

• . •, - . • ' •· " ·· · , f · : ''

;ne the equilibrium level of out · · · ·· · ' ·
oeterrnd. . ns o1 equilibrium. Ca/cul t t put using both the first order and second
con ,t,o . a e otal profits made
0,Jersotutt•00 • .Profits are maximised ·w h th f· ·
. . en e irm equates marginal cost with MR and
_,.tttinal cost i,s nsmg. Thus, m order to obtain the equilibrium output w t . IL-tC ,;; MR
IJP';:i,- . TR = 12Q . . . e equa e '"'' .
I ,I ' • ' • ti ' I • I
I '.
,
I
I , I

.,,. .._- - MR ;., dTR ,~ 12

· , .1 dQ , . ..

l ,. f ' .
( . : I ) f I : t dTC- .. .
MC= _ ., ~4+2Q
• I ~ r 1 \\ •
' ,--. \,• ", l
dQ.. , . \ !, r,,, ·.' , - I
• i·, ••• . \ ..... , • ~ ' •

In equilibrh.µn, · .w .. · ~
. MC' ,., 1 ,.·\ • • ' -.•' ,. '.I• , • .
I • : '" ' t •\ L ' ' • -. t' ! '
.-·,:··,,.
•
·, \,': .· '• '. •,• \ ;

' .. = MR •I ' -
0
,1
I l •
I. ' I • I \ ' ' , ·, . ' ' • \ . - ' , ' • I . .1
•l • • - I ' • ' ,<J ~ • I • • ••

4 + 2Q = 12 -~ - ·- ·- ~ , - - -. --· . . .
- Q :: 4 • - -. . . -· . . I ' ~ I.. '_ ~ ' .• - '. -~ ,\

Total profits (1t) ;,,. TR-TC .

= 12Q - (2 + 4Q ~ Q2)' . "
Substituting Q = 4, we have ~I
7t = (12 X 4) - 2 - (4 X 4) - 16
= 48-34 = 14
Note that in order to ensure for the fulfillment of second order condition, we have to test
1
whether MC is rising. For this, we take the derivatiJe of MC i.e-.-·second derivative of TC
' (- •. I 4 •• I .• ~ t '. . :- ,· 1 :.. ..: . :·, . ''; . l ' • I . i I .: ~ • ~

Thus;
I,'
· · MC d:1 dTC. .;;,
• 1
• ·:,·.· dQ ·· ~:,,/
4•j 20.. ·'· ·.· ; ,. ·· ·
, 1 f •
·'
., • . I ..,,• I .. - • , J •• , r -. ' , .• ,. ,' ' • •

• '
. '
'
,
I• • ' •

, . .....: ...•. --·--

2 TiC - ·-·-·- .
1.·, I d - -+2 '\}
.- ' - , '1
. '·,,• , . )

• pQ:....~ - .:.•,. ---•--•••~ -· • ·-• I

The positive sign of the second derivative ~f TC implies that MC is rising.

Problem 8. Suppose that reve~ue and total cost of a fir,:n ?re gil;)en by the equations:
R= 60Q ·.! .
and C = 10 + SQ2, (Q = output). . ·: ·
Using TR-TC approach find what will be the profit-maximising output and total
Profit of the firm?
Solution : .
_ _ _ _ r : .. __ -· -1t =· TR - TC · -· -- ·
• i ; - .' ' '. ' •. •. ·=60Q..;.1Q-5Q2 '• i,_-,i ··:.· .'

1ticu':~t~,':,maxim~. a\ the,level, of o,~t ~~ ~~~-.the.fi~ ~~live of t~tal pro~ . : ' ..

r • •
. .
... d7ti° I
. .
I • ,
.
) \ J \' , • • )

··· ..· - a= 60- l0Q

... .. .dQ I '
. • ~• . ,~t I', • I• ; I •
' ,:
..
.'
1
• • , J }.~;, ' ~. ' '

d1t . .- -· - .. . ·• ... . - . .~ ..
Setting dQ equal ~o ~~ero ~e ~~ve~ ' -~~ .. ·.• ••. . •·•• • ·• • ', I

.160 - l0Q = 0 :.:: : ;

· · : . l0Q = 60 _. : ·
(:, 1 Q = 6 . \, l