REVENUES, PRODUCER'S EQUILIBRIUM AND THE SUPPLY CURVE 67

4.1 Total Revenues

4.2 Producer's Equilibrium:The Basis of the SupplyCurve

4.3 Change in QuantitySupplied Versus Changein Supply

4.4 Determinants of SupplyCurves

4.5 Market Supply Curve

4.6 Time Horizon

4.7 Price Elasticity of Supply

Besides the demand forces, the supply forcesconstitute the other crucial component ofmarket mechanism. It is the producers whosupply goods and services to the market. Inthe last chapter we studied conceptsassociated with production and cost, whichare relevant for producers. But we did notlearn about their choice behaviour i.e. whichlevel of output they should produce so as tomaximise their profits. In this chapter wedevelop the revenue concepts, and, togetherwith the cost concepts, we study profitmaximisation. This, in turn, forms the basisof what is called the supply curve.Comparable to the demand curve, the supplycurve shows different quantities producedand sold at different prices.

In the last chapter, we saw that profits areequal to the difference between total revenuesand total costs. We also discussed how totalcosts change with output. In this chapter, wefirst analyse how total revenues, defined asprice × output, change with output. This setsthe stage for analysing profit maximisation orwhat is called producer’s equilibrium. It isan equilibrium notion in the sense that if thefirm selects the level of output at whichprofit is maximised, it would like to “stay” or“rest” at that level of output; there is

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CHAPTER 4

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INTRODUCTORY MICROECONOMICS68

no incentive for it to increase ordecrease output from that level.

4.1 TOTAL REVENUES

Unlike costs, the effect of a change inoutput on the total revenue of a firmdepends on the market structure,which refers to the number of firmsoperating in an industry, the nature ofcompetition between them and thenature of the product. In this chapter,we will consider only one kind of marketstructure, namely, perfect competition,which is of central importance ineconomic analysis. Other types ofmarket structure will be studied inChapter 6.

4.1.1 Perfect Competition

The following six characteristics defineperfect competition or a perfectlycompetitive 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, whichexactly fit the definition of perfectcompetition. But the markets for goodsand services like wheat, a standard hair

cut or a leather football can be thoughtof as examples of industries, which arevery close to perfectly competitivemarkets. Because, there are typicallymany producers of these items. Eachof these is a standardised item, i.e.,naturally homogeneous. Moreover, it isrelatively easy to enter or get out of thesebusinesses.1

The implication of the product beinghomogeneous or identical is that allfirms have to charge the same pricefor the product. That is because if oneproducer happens to charge a pricehigher than some other, no one will buyfrom the former. Why would anyone paymore for exactly the same item? Hence,all producers who operate in the marketmust charge the same price. Producthomogeneity and the existence of alarge number of firms together implythat each firm is very small comparedto the whole market and no single firmcan influence the market price. That is,each firm is a price taker in perfectcompetition.2 An example may help tobetter understand the price takingbehaviour.

Think of a product like jalebi (asweet). If you operate a halwai(sweetmeat) shop in a big town in whichthere are many such halwai shops,

1 You can of course argue that there may be some differences between wheat produced in Punjab andwheat 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 sameeverywhere. 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.

2 This does not mean that the market price itself cannot change. How it may change will be studied inChapter 5.

REVENUES, PRODUCER'S EQUILIBRIUM AND THE SUPPLY CURVE 69

and, the market price of jalebi per kg isRs. 70, you will charge Rs. 70 too.Obviously, you will not charge more thanRs. 70 (and lose a lot of, possibly, allcustomers). There is also no reason foryou to sell at any price less, becausebeing small compared to the market,you can “sell” as many jalebi as you likeat the going price in the market. Thusyou will be a price taker.

4.1.2 Total Revenue Curve andPrice Line

Once you understand that each firmis a price taker and can sell as manyunits as it wishes at the market price,it is quite simple to relate total revenue(TR) to output.3 For example, if yousell five kilograms of jalebi, the TR isRs. 70 × 5 = Rs. 350. If you sell six, it is

Rs. 420 and so on. Table 4.1 reportsthe total revenue schedule for thisexample.

4.1.3 Total Revenue Curve andPrice Line

If we graph the total revenue schedule,measuring output along the x-axis andtotal revenue along the y-axis, we obtainthe total revenue curve. This is depictedin fig. 4.1(a). At zero output, TR isobviously zero. Hence the TR curvemust pass through the origin.Moreover, it is a straight line. This isbecause the market price isindependent of how much quantity issold by one firm. Turn to fig. 4.1(b)now. The y-axis measures price, nottotal revenues. Since the market priceis given or “exogenous” to the firm, weobtain a horizontal line. This is calledthe price line. It is also called the“demand curve facing a competitivefirm” in the sense that, from a firm’sperspective, it is able to sell to theconsumers any amount it wishes atthe same price. (The price elasticity ofthis demand curve is infinite.)

There is a relationship between theprice line and the total revenue. Thatis, the total revenue is equal to the areaunder the price line. This is seen infig. 4.2, in which AB is a hypotheticalprice line. Suppose that the firm isproducing the amount q0. Then, TR =price × quantity = OA × Oq0 = OADqo,which is the area under the price line.

Table 4.1 Total Revenue Schedule

Output In Kg. TR (Rs.)

0 01 70

2 140

3 210

4 280

5 350

6 420

7 490

8 560

*Market price jalebi = Rs. 70/kg

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

INTRODUCTORY MICROECONOMICS70

4.1.4 Average Revenue andMarginal Revenue

These are two more “revenue” concepts.Average Revenue (AR) is defined asrevenue per unit of output. It is equalto TR/output. Note that, since TR =price × output, AR is always equal toprice.

Marginal revenue is defined as theincrease in total revenue when oneextra unit is sold, i.e., it is therevenue obtained from one extra orlast unit sold.4 Since a competitivefirm is a price taker, if it sells oneextra unit, the extra revenuegenerated will be equal to whateverthe price is. Thus, for a competitivefirm, MR = price.5

However, the terms of AR and MRwill not be used much in this chapter.But they will be in Chapter 6. Here theyare introduced for the sake ofcompleteness.

4.2 PRODUCER’S EQUILIBRIUM:THE BASIS OF THE SUPPLYCURVE

We are now ready to study producer’sequilibrium. The question is at whatlevel of output will a firm’s profit bemaximised? Unlike the numericalmethod that was used in Chapter 2 tostudy consumer’s equilibrium, we usea graphical method to answer thisquestion. In order to do so, we need tworesults from our study of costs andrevenues:

Fig. 4.1 Total Revenue Curve and thePrice Line corresponding toTable 4.1

Fig. 4.2 Price Line and Total Revenues

(a)

(b)

4 This is similar to the concept of marginal utility or marginal cost.5 This is not true for a firm, which is not perfectly competitive.

REVENUES, PRODUCER'S EQUILIBRIUM AND THE SUPPLY CURVE 71

1. The total variable cost is equal tothe area under the marginal costcurve.

2. The total revenue is equal to thearea under the price line.

4.2.1 The Profit-MaximisingCondition

Turn now to fig. 4.3. Suppose that acompetitive firm faces the market priceP0, that is, P0A" is the price line. Itsmarginal cost curve is denoted by MC.At which level of output is the firm’sprofit maximised? The answer is q0. Inother words, we are saying that, ingeneral, a competitive firm’s profit ismaximised at the point where the priceline intersects the MC curve, i.e., where(A) P = MC,with P denoting the market price. Thisis the profit maximising condition or thecondition for producer’s equilibrium.6

Why is profit maximised where theprice line intersects the MC curve?Define gross profit equal to TR – TVC.By definition, this is equal to profit plusTFC. However, since TFC is constant,profit is maximised where gross profitis maximised and vice versa. We nowargue that, at the market price P0, thegross profit is maximised at the outputq0, where the price line P0 intersects theMC curve.

We have TR = the area under theprice line = 0P0Aq0, and TVC = the areaunder the MC curve = 0DAq0 . Thusgross profit = 0P0Aq0 – 0DAq0 = DP0A.Now consider any output less than q0,

say q'. By similar calculation, the grossprofit = DP0A'B. Notice that this is lessthan DP0A. Look at next, a level ofoutput greater than q0, say q". The totalrevenue is equal to 0P0A"q" and the totalvariable cost is equal to 0DCq"; thusgross profit = 0P0A"q" – 0DCq" =DP0A – ACA". This is also less thanDP0A. Hence, at any level of outputeither less or greater than q0, the grossprofit is less. This proves that grossprofits, and, hence profits, aremaximised at q0, where P = MC.

Fig. 4.3 Profit Maximisation

4.2.2 Rationale Behind theCondition, P = MCIn Chapter 2 we saw that diminishingmarginal utility is the key behind theconsumer’s equilibrium condition of“marginal utility is equal to price.” In aparallel way, the key reason behindthe producer’s equilibrium condition,P = MC, is that marginal cost beincreasing with output.

To see this, suppose that, startingfrom the level of output at which P=MC,

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

INTRODUCTORY MICROECONOMICS72

the firm decides to produce one unitmore. Given that MC is increasing inoutput, P will be now less than MC.But P and MC are respectively equalto extra revenues earned and extracosts incurred. Hence, extra revenueswill be less than the extra costs,implying that the profits will be less.Similarly, suppose that the firmdecides to produce one unit less thanwhere P = MC. In this case therevenues sacrificed (equal to P) aregreater than savings in costs (equal toMC). Hence, profits will also be less.In summary then, increasing ordecreasing output from where P = MCresults in less profits. Thus, profit ismaximised where P = MC, as long asMC is increasing in output.

The above discussion implies that,if at any given market price there is alevel of output at which P = MC holds

but MC is decreasing, it cannot be theprofit-maximising level of output. Sucha possibility is shown in fig. 4.4. Atprice P1, the price line cuts the MCcurve at two points, q1

a and q1b, but,

unlike at q1b, at q1

a, MC decreases.Therefore, the profit-maximisingoutput is q1

b not q1a .7

The preceding analysis gives riseto an important conclusion: acompetitive firm chooses an outputonly on the rising portion of the MCcurve.

4.2.3 A More General Profit-Maximising Condition

Recall the definition of MR, themarginal revenue, and that P = MR fora competitive firm. Thus we can write(A) as MR = MC. That is, marginalrevenue is equal to marginal cost.Indeed, this is a very general conditionof profit-maximisation − somethingthat holds irrespective of the marketstructure.

Having noted this, we however returnto P = MC as our profit-maximisingcondition for a competitive firm.

4.2.4 Law of Supply and the SupplyCurve

The law of supply states that, otherthings remaining unchanged, anincrease in the price of a product leadsto an increase in the quantity suppliedof it. It is because, higher the price, themore a producer wants to supply.

Fig. 4.4 Profit Maximising Outputs atDifferent Prices

7 Suppose the firm is producing at q1a. 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 ishigher. You can similarly argue that profit is less also if output is reduced by one unit from q1

a. Hence,profit is not maximised at q1

a.

REVENUES, PRODUCER'S EQUILIBRIUM AND THE SUPPLY CURVE 73

“Other things” refer to otherdeterminants of supply, which will bediscussed later.

This law, stated in a tabular form,gives rise to the supply schedule, and,the graph of a supply schedule givesthe supply curve. Table 4.2 lists asupply schedule. Figure 4.5 graphs thecorresponding supply curve.

What is the basis of the law ofsupply or the supply curve? Refer backto fig. 4.4. We see that, at price P1, thefirm produces the amount q1

b, at priceP2, it produces q2; and so on. Hence all

price-output combinations are simplythe points on the rising part of the MCcurve. We can think of the output asthe amount supplied to the market(assuming implicitly that the firmdoes not store anything beyond oneperiod). Hence it follows that the risingportion of the MC curve is the supplycurve itself ! 8

4.3 CHANGE IN QUANTITYSUPPLIED VERSUS CHANGE INSUPPLY

The difference between these two termsis similar to the difference between achange in quantity demanded and achange in demand. A change inquantity supplied refers to a movementalong a given supply curve because ofa price change, whereas a change insupply means a shift of the supplycurve due to a change in “other factors.”It is now the time to discuss thesefactors.

4.4 DETERMINANTS OF THESUPPLY CURVE

Since the supply curve is a part of themarginal cost curve, the factors thatshift the marginal cost curve are thedeterminants of supply or the supplycurve. Generally, there are two suchfactors, technological changes andchanges in factor or input prices.

Besides, in India particularly, onmany industrial goods, there are taxesthat are based on the total production

Table 4.2 A Supply Schedule

Price (Rs.) Quantity Supplied

5 0

10 7

15 16

20 28

25 43

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

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

INTRODUCTORY MICROECONOMICS74

cost of output of a firm. These are calledexcise taxes or excise duties. As wewill see, a change in the rate of exciseduty will also shift the supply curve.

There is still another factor that oursimple profit-maximising analysis doesnot capture, namely, changes in theprices of related goods.

In what follows, we consider thesedeterminants of supply. 9

4.4.1 Technological Changes

Science and research laboratoriesaround the world as well as thebusiness firms themselves look for newtechnology or methods that reducecosts of production. Consider forinstance the printing business. In olddays, bringing out a book in print wasa fairly complex process.10 Now a days,with computers, word processing,spread sheet and presentationpackages, all tasks except for printingare done in a computer. Changes arenearly costless to include. Usingprinters to print is also an easy andfairly inexpensive job. The average andmarginal costs facing a commercialpublisher for any given number of

printed pages are much less today thanthey were prior to 1980s. This is anexample of cost-saving technologicalchange. In the real world, there aremany such examples.11

Such a technological advance lowersmarginal cost at any given level ofoutput. Table 4.3 illustrates this.Column (2) lists an old marginal costschedule. Column (3) lists the new oneafter the technological change.12 Noticethat each entry in Column (3) is smallerthan the corresponding entry inColumn (2), meaning that the marginalcost has decreased for any given level ofoutput. The two marginal cost schedulesare plotted in fig. 4.6. As we can see, thenew MC curve lies below or to the right ofthe old one. Since the MC curve isessentially the supply curve, we have theresult that a technological progress shiftsthe supply curve to the right.

4.4.2 Input Price Changes

Changes in raw material prices, wagesto workers etc. can also affect themarginal cost curve and the supplycurve. Suppose you own a haircut

9 There are chance factors like weather changes or health of workers, which can also shift the marginalcost 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 oftheir product to the market, expecting to sell later at very high prices. We ignore these factors in thischapter.

10 Once manuscripts of books were prepared by authors in long hand, the alphabets in the manuscriptsused to be set in a frame and the frame would be mounted on a letter-press machine. The pictures anddiagrams were etched on metal plates. The whole plate had to be changed if changes were to be madein the pictures or diagrams. The metal plate and the frame were mechanically inked and pressed on topaper to produce a page of the book.

11 There is another kind of technological progress that we do not consider here, namely, development ofnew products.

12 For simplicity, in both cases, the marginal cost always increases with output.

REVENUES, PRODUCER'S EQUILIBRIUM AND THE SUPPLY CURVE 75

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

Table 4.3 A Decrease in MarginalCosts due to Technological

Change

Output Old MC New MC(Rs.) (Rs.)

0 7 3

1 8 4

2 12 7

3 14 9

4 17 13

5 22 17

Fig. 4.6 Technological Progress and Shiftof the Supply Curve

saloon, employ 10 barbers and service120 haircut jobs a day now. The hourlymarket wage of barbers increases forsome reason. This will increase thecost of the haircut service that youprovide and shift your marginal costcurve up or to the left. As a result, youwill employ fewer barbers and serviceless number of haircuts.

In general then, an increase (adecrease) in an input price shifts thesupply curve to the left (right). The case

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

4.4.3 Changes in the Excise TaxRate

In India, producers of variousindustries in the manufacturing sectorpay excise taxes. As said earlier, theseare taxes levied on the total productioncost of a firm. Hence they add to thetotal variable cost. Therefore, a changein the rate of this tax affects the overallmarginal cost.

Suppose the rate of excise duty ona particular product increases. For anygiven level of output, this wouldincrease the marginal cost and henceshift the MC curve and the supplycurve to the left.

Thus, an increase (a decrease) inthe excise tax shifts the supply curveto the left (right).

4.4.4 Change in the Prices ofRelated Products

Many producers, with their givenamount of resources, manufacture or

INTRODUCTORY MICROECONOMICS76

grow more than one item. Consider afarmer who has a given amount of land,which he can use to produce wheat orcorn (or both). If the market price ofwheat increases, he will grow less corneven when the price of corn, thetechnology of producing corn and inputprices (e.g. the price of corn seeds)remain the same. It is because growingcorn is less profitable now, comparedto growing wheat. This will shift thesupply curve of corn to the left.

Thus an increase (a decrease) inthe price of a substitute good inproduction shifts the supply curve ofa good to the left (right).

4.5 MARKET SUPPLY CURVE

This is parallel to the market demandcurve. It is derived as the horizontalsummation of individual supply curves.In Chapter 2 the market demandschedule was obtained by numericallyadding up individual demandschedules. Here, the market supplycurve is derived in an equivalent,geometric way (so that you get to knowboth ways).

Assume that there are two firms inan industry, A and B. In fig. 4.8 thecurves SA, SB and SA+B respectivelydenote A’s supply curve, B’s supplycurve and the market supply curve. Forexample, at price P1 the producer Asupplies A1 units and the producer Bsupplies B1 units. The total quantitysupplied to the market is then A1+B1,shown along the SA+B curve against thisprice. Similarly at P2, the total quantitysupplied is A2+B2, where A2 and B2 arequantities supplied by producers(firms) A and B respectively. All otherpoints on the market supply curve arederived in the same manner.

Note that a market supply curve isderived on the assumption of a givennumber of firms (100, 200 or whateverit may be). Hence, apart from any factor,like a technological change or a changein any input price, that shifts theindividual supply curve and therebythe market supply curve, the latteralso shifts when the number offirms changes. An increase(a decrease) in the number of firmsshifts the market supply curve to theright (left).

Fig. 4.8 Individual Supply Curves and the Market Supply Curve

REVENUES, PRODUCER'S EQUILIBRIUM AND THE SUPPLY CURVE 77

When there is an increase (adecrease) in the number of firms, we saythat there is more (less) competition inthe market. Thus, we can also say thatmore (less) competition shifts themarket supply curve to the right (left).13

4.6 TIME HORIZON

An element of time lies behind thesupply curve being upward sloping.Suppose that you manufacturechewing gum. The market price thathas been prevailing for a long time isone rupee a piece. At this price, youwere producing 1 lakh chewing gumsper month. Now suppose the priceincreases to two rupees a piece. This isgood news for you. As a rationalproducer, you would want to producemore by hiring more workers, morechemical engineers, more equipmentetc. This will mean that your supplycurve is upward sloping.

However, it takes time to hire people,get new machinery etc. Within a veryshort period, you cannot make thesechanges. Your production level in a veryshort period of time is given, irrespectiveof whether the price may have changedto Rs. 2, Rs. 3 or Rs. 1.50. The resultingsupply curve will be a vertical line, asshown in fig. 4.9. Such a short period

is called the market period ineconomics. By definition, it is that shorta period within which firms cannotadjust their output to any change inprice. As a result, the supply curve of afirm or the whole industry is vertical.

In a longer run − i.e. in the shortrun or long run − the supply curve willbe upward sloping, as drawn earlier,because inputs can be changed.

13 As you know, India has been following a path of economic liberalisation, especially since the 1990s.Many foreign firms that couldn’t 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 ofthis.Until the seventies, in the passenger car market there were only two companies that were allowed tooperate: Hindustan motors (with Ambassador) and Fiat (with Premier Padmini). In the 1980s cameMaruti, which is owned jointly by the Indian government and Suzuki Motor Corporation of Japan. In the1990s, 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).

Fig. 4.9 Supply Curve in the Market Period

4.7 PRICE ELASTICITY OF SUPPLY4.7.1 Definition and the Percentage

Method of Measurement

Parallel to price elasticity of demand,the price elasticity of supply quantifiesthe responsiveness of quantity suppliedto changes in price. It is defined as(B) Price elasticity of supply = es

INTRODUCTORY MICROECONOMICS78

price the in change% supplied quantity the in change%

On a given supply curve, let P0 andS0 denote the original price andquantity. If the price rises to P1 andquantity supplied increases to S1, the% changes in price and quantitysupplied are respectively[(P1 – P0 )/P0] × 100 and [(S1 – S0 )/S0] ×100. Hence

,//

/)(/)(

)(0

0

001

001

PP

SSPPPSSS

seC∆∆=−

−=

where ∆ denotes the change.If the supply curve is vertical, then

the price elasticity of supply is,obviously, zero. Otherwise, given thatthe supply curve is positively sloped,the price elasticity is positive.

As a numerical example, supposethat you manufacture one type of ball-point pens. When they were selling atthe price Rs. 8, you produced and sold5,000 pens a month. Now its marketprice has increased to Rs. 10 and youare producing and selling 8,000 pensa month. In this example, P0 = Rs. 8,

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

Thus,

,25100]8/)810[(100]0/)01[( PPP

and

.60100]5000/)]50008000[(

100]0/)01[(

=×−

=×− SSS

Hence, .4.225/60Se

Just as in case of price elasticity ofdemand, (a) the price elasticity of supplyis independent of units, and (b), if twosupply curves intersect, the flatter onehas higher price elasticity at the point ofintersection. The reasons are exactlyparallel what they were in case of priceelasticity of demand.

4.7.2 The Geometric Method

Also similar to point elasticity of demand,for very small price changes, the priceelasticity of supply can be measured by aconvenient geometric formula.

Refer to fig. 4.10. It shows threestraight line supply curves. Panel (a)illustrates one, in which the supplycurve, extended towards the x-axis,intersects the x-axis in its negative

Fig. 4.10 Price Elasticity associated with Straight Line Supply Curves

(a) (b) (c)

REVENUES, PRODUCER'S EQUILIBRIUM AND THE SUPPLY CURVE 79

range at point B. In fig. 4.10(b), thesupply curve intersects the x-axis inits positive range. Finally, in fig. 4.10(c),the point of intersection is the origin;that is, the straight line supply curvepasses through the origin. In all panels,P0 is the original price, 0C is thequantity supplied and A is the pointon the supply curve.

It turns out that the point elasticityis equal to the horizontal segment BCdivided by the quantity supplied 0C,that is, BC/0C. 14 (Ignore for the momentfig. 4.1.(c) in which there is no point B.)

Thus, along the supply curve inpanel (a), the price elasticity is greaterthan one (as BC > 0C). By the sameargument, along the supply curvein panel (b), it is less than one(as BC < 0C).

Finally, in panel (C), you can saythat the point B is same as the origin.Thus BC = 0C implying es=1. Thatis, any straight line supply curvepassing through the origin,irrespective of how steep or flat it is,implies price elasticity of supplyequal to one.

CLIP 4-1Does computerisation reduce employment?

This is a sensitive issue for a populous country like India. The traditional thinkingis that computerisation – or for that matter, any technical improvement that islabour-saving – is or must be bad for employment. If you replace a person with amachine, how could it not reduce employment? This is, however, a narrow point ofview, 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 orare incapable of developing any other skills and hence must remain unemployedfor a long time.Yes, at the time when a machine is replacing a person or many persons, it has anegative effect on employment. But this is hardly the end of the story. A firm is doingit in order to save costs. As the total variable cost curve shifts down, so does themarginal cost curve. This means that the supply curve will shift out and more will beproduced in the new equilibrium. From the whole economy’s perspective, the productionpossibility curve (see Chapter 1) shifts out. Higher output would require moreemployment of workers, both skilled and unskilled. Also, computerisation by itselfcreates demand for new types of jobs. Hence there is little reason to believe thatcomputerisation will reduce employment in the long run. On the other hand, it leadsto a greater productivity of workers and higher wages.The negative effects of computerisation are present only in the short run. Atraditional typist who is replaced by a computer can learn word processing andpossibly land a more paying job. Of course, computerisation or mechanisationmay, 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.

INTRODUCTORY MICROECONOMICS80

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 andcannot change their skills may not get their jobs back, but other category of workerswill now find jobs.In summary, there may be employment costs of computerisation, but only in theshort run. On the other hand, there are major long-run benefits.

SUMMARY

� The total revenue curve facing a competitive firm is a straight line passingthrough the origin.

� The price line facing a competitive firm is horizontal because this firm isa price taker.

� The price line is also interpreted as the demand curve facing a competitivefirm.

� A perfectly competitive firm maximises profits, i.e., attains producer’sequilibrium, when price is equal to the marginal cost.

� In general, a firm’s profit maximising condition is that marginal revenueis equal to marginal cost.

� The profit-maximising condition, price is equal to marginal cost, formsthe basis of the supply curve.

� Increasing marginal cost explains the law of supply or why the supplycurve is upward sloping.

� A firm’s supply curve consists of the rising portion of its marginal costcurve.

� A cost saving technological progress shifts the marginal cost curve downand hence shifts the supply curve to the right.

� An increase in input prices shifts the marginal cost curve up and henceshifts the supply curve to the left.

� An increase in the rate of the excise duty shifts the supply curve to theleft.

� An increase in the price of a substitute good in production shifts thesupply curve of the product in question to the left.

� Market supply curve is obtained by horizontally summing up theindividual supply curves.

REVENUES, PRODUCER'S EQUILIBRIUM AND THE SUPPLY CURVE 81

EXERCISES

Section I4.1 What is meant by producer’s equilibrium?4.2 What is the relationship between total revenue, price and

quantity sold?4.3 What is the relationship between price and marginal revenue

for a competitive firm?4.4 What is the condition of producer’s equilibrium for a competitive

firm?4.5 What is the condition of profit maximisation for a competitive

firm?4.6 What is the general profit maximising condition of a firm?4.7 What is meant by the Law of Supply?4.8 What is meant by a change in the quantity supplied?4.9 What is meant by a change in supply?

4.10 Due to improvement of technology, the marginal costs ofproduction of televisions have gone down. How will it affectthe supply curve of television?

4.11 What effect does a cost saving technical progress have on thesupply curve?

4.12 What effect does an increase in input price have on the supplycurve?

4.13 What effect does an increase in excise tax rate have on the supplycurve of the product?

� An increase in the number of firms shifts the market supply curve to theright.

� During the market period, the individual and the industry supply curvesare vertical.

� Price elasticity of supply measures the responsiveness of quantitysupplied to a change in its own price.

� A straight line supply curve which intersects the x-axis in its negativerange implies price elasticity of supply greater than one.

� A straight line supply curve which intersects the x-axis in its positiverange implies price elasticity of supply less than one.

� A straight line supply curve passing through the origin implies priceelasticity equal to one, irrespective how steep or flat it is.

INTRODUCTORY MICROECONOMICS82

4.14 If a farmer grows rice and wheat, how will an increase in theprice of wheat affect the supply curve of rice?

4.15 What is meant by ‘market period’?4.16 How will an increase in the number of firms shift the market

supply curve?4.17 What does price elasticity of supply measure or quantify?4.18 If two supply curves intersect, which one does have higher price

elasticity?4.19 What is the price elasticity associated with a straight line supply

curve passing through the origin?

Section II4.20 Why is the total revenue curve facing a competitive firm a straight

line passing through the origin?4.21 What factors determine the market structure?4.22 What are the features of perfect competition?4.23 What is meant by a product being perfectly homogeneous? What

is its implication for the price charged by producers in themarket?

4.24 Briefly explain why a perfectly competitive firm is price-taker inthe market.

4.25 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?4.26 Complete the following table when each unit of a commodity

can be sold at Rs. 5.

Quantity Sold TR MR AR

1

2

3

4

5

6

7

REVENUES, PRODUCER'S EQUILIBRIUM AND THE SUPPLY CURVE 83

4.27 A firm’s TR schedule is given in the following table. What is theproduct price facing the firm?

4.28 Why is AR always equal to MR for a competitive firm?4.29 Name three factors that can shift a supply curve.4.30 Give two examples where technological progress leads to a shift

in the supply curve.4.31 How does a change in the price of inputs affect the supply curve

of a commodity and why?4.32 How does an increase in the rate of excise tax shift the supply

curve and why?4.33 How does a cost saving technological progress shift the supply

curve and why?4.34 A new technique of production reduces the marginal cost of

producing stainless steel. How will this affect the supply curveof stainless steel utensils?

4.35 Because of cyclone in a coastal area, the sea level, covers a lot ofrice fields. This reduces the productivity of land. How will itaffect the supply curve of rice of that region?

4.36 Consider the following individual and market supply schedules.

Price Firm A Firm B Firm C Market(in Rs./kg.) (kg.) (kg.) (kg.) (kg.)

1 — 20 45 100

2 37 30 50 —

3 40 — 55 135

4 44 50 — 154

5 48 60 65 —

Output TR (Rs.)

1 7

2 14

3 21

4 28

5 35

INTRODUCTORY MICROECONOMICS84

(a) Complete the above table on quantities of potatoes suppliedby the firms and the market.

(b) Plot the supply curve of each firm and the market supplycurve in a single diagram. What relationship do you observebetween the individual supply curves and the marketsupply curve?

(c) Calculate the price elasticity of supply of Firm A when pricerises from Rs. 2 to Rs. 3.

4.37 Draw straight line supply curves with (a) unitary price elasticityand (b) zero price elasticity.

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

Section III4.39 Show that the rising portion of the marginal cost curve is the

supply curve of a competitive firm.