Solved questions on firm and industry

1- What do you mean by firm & industry?

Ans:- It is important to know the meanings of firm and industry before analyzing the two. A firm is an organization which produces and supplies goods or services that are demanded by the consumers in the market. According to Prof. S.E. Lands-bury, “Firm is an organization that produces and sells goods with the goal of maximizing its profits. In the words of Prof. R.L. Miller, “Firm is an organization that buys and hires resources and sells goods and services.”

An industry is a group of firms producing homogeneous products in the market. In the words of professor Miller, “Industry is a group of firms that produces a homogeneous product.” For example, wai wai, Ra Ra, 2PM, ABC, Lekali, Ru-chee etc are the noodles produced by the Nepalese firms, whereas a group of such firms is called the noodle industry.

2- What do you mean by equilibrium of a firm & an industry?

Ans:- A firm is said to be in equilibrium when it has no incentive either to expand or to contract its output and it might be making a possible maximum profit or incurring a minimum loss. It is an important situation of a firm’s equilibrium.

The concept of equilibrium of industry is equally important in the analysis of price determination, particularly in product-pricing. An industry is said to be in equilibrium when there is no tendency for its output to increase or decrease. The output of the industry can vary, firstly by the expansion or contraction of output of the individual firms, and, secondly, by the entry or exit of the firms. Thus, an industry would be in equilibrium when neither the individual firms have incentive to change their output nor is there any tendency for new firms to enter or the existing firms to leave it.

3- Explain the short run equilibrium of firm under perfect competition market with TR-TC approach.

Ans:- According to this approach the firm attains equilibrium in the short-run when the profit is maximum or the positive gap between total revenue TR and total cost TC is the widest.

Symbolically, π =TR-TC

In perfect competition, the price of the commodity is fixed as determined by the market forces. The increase in output sold brings about a proportional increase in total revenue. As a result, total revenue curve straightly slopes upward to the right forming 45* angle at the origin. 

Total cost initially increases at a diminishing rate, and thereafter it increases at an increasing rate with the increase in output. So the TC curve initially slopes upward slowly and thereafter at a faster rate with the increase in output.

The equilibrium of a firm under TR - TC approach is shown in figure below.

In the above figure, the firm is in equilibrium at point B where it is producing the output equal to OD at which the gap between TR and TC is the widest, equal to BG. It is the point at which the firm maximizes its profits. When the firm produces more than OD, the gap between TC and TR starts to narrow and the profit minimizes. At points A and E, TC and TR are equal to each other and the firm gets no profits at these points. To the left of point A, the firm bears losses indicated by shaded area and beyond point A, profit goes on increasing up to point B. Thereafter, profit goes on decreasing up to point E. Beyond E, the firm incurs losses. Hence, the maximum profit that the firm enjoys at the point where the gap between TR and TC is the widest. At this widest point it produces OD output and maximizes profit equal to BG as shown in the figure.

4- Explain the short run equilibrium of firm under perfect competition market with MR-MC approach.

A firm is in equilibrium in the short-run when it has no intention to expand or contract its output and wants to gain maximum profit or incur minimum losses. In other words, a profit maximizing firm attains its equilibrium at the level of output at which its marginal revenue is equal to marginal cost or MR = MC and the slope of marginal cost curve MC is greater than marginal revenue curve MR. Thus, there are two basic conditions that should be fulfilled for equilibrium.

Symbolically,

MR=MC, Marginal revenue is equal to marginal cost,

MC>MR, The slope of MC is greater than MR

Assumptions:

The short-run equilibrium of a firm is analyzed under the following assumptions:

1-Capital cost is fixed but labor cost is variable;

2-Prices of inputs are given;

3-Price of the commodity is fixed;

4-Cost curve of firms vary from each other;

4-Firms produce and sell different quantities;

The firm’s equilibrium in the short-run equilibrium is illustrated in figure-2. As shown in figure, the market equilibrium price of a commodity is determined equal to 0P by the market forces, demand and supply, intersected by demand and supply curve at point E. the price 0P is fixed for all the firms of industry. Therefore, a firm faces a horizontal demand curve as MR. This curve shows that the price is equal to MR and also to AR. The short-run average and marginal curves of the firms are shown by SAC and SMC, respectively.

As shown in the figure by Firm-A, the SMC curve intersects MR curve at point E from below. At this point SMC = MR and SMC > MR or the conditions required for the equilibrium have been fulfilled here. Hence, E is the point of equilibrium at which 0Q level of output is determined. This is the equilibrium level of output which yields maximum profit for the firm as shown by the shaded area REPS

The above figure-2 shows that Firm-A makes supernormal profit. However, in the short-run equilibrium, a firm may not always make supernormal profit. It may make a normal profit or even make a loss. The profit or loss of a firm basically depends on its cost and revenue conditions. Given the price, if its short-run average cost SAC is below marginal revenue MR at equilibrium point or at the point where MR = MC and MC curve intersects MR curve from below, the firm makes supernormal or abnormal profit as shown by Firm-A in figure-3. It is shown by Firm - A that E is the point of equilibrium at which SAC is below MR by ER. Hence, the firm enjoys supernormal profit equal to REPS.

A firm can make even a normal profit as it covers only its SAC. It happens when SAC is equal to MR at equilibrium point or at the point where MR = MC and MC curve intersect MR curve from below, as shown by Firm-B in the figure. It is shown by Firm - B that E is the point of equilibrium at which SAC = MR. Hence, the firm makes only normal profit.

In the short-run, a firm may attain its equilibrium even if it makes losses. If its SAC is above MR at equilibrium point or at the point where MR = MC and MC curve intersects MR curve from below, it makes losses as shown by Firm-C in the figure. It is shown by Firm - C that R is the point of equilibrium at which SAC is above MR by ER.Hence, the firm incurs losses equal to REPS.