Question

In order to understand Managerial Economics. I need to understand the Theory of the Firm. Also a clear explanation of the following and how each is calculated. Marginal Cost, Marginal Revenue, Profit Maximization Goal, and Marginal Profit.

Answer 1

Answer : A theory of firms explain how the firm behave under different market condition.

Theory of firm included different theories such as :

• Production theory
• Revenue theory
• Cost theory
• Profit maximization in different types of market

Four market structure exist such as :

• Perfect competition
• Oligopoly
• Monopoly
• Monopolistic

Before understanding theory of firm we need to understand the following terms such as :

• Marginal cost : It is cost added to produce one more unit of product or service. Marginal cost is the additional cost occurred to produce an extra unit. MC = ∆TC/∆Q

This formula represents change in total cost with respect to change in quantity produced.

• Marginal revenue : It is an extra revenue generated from selling goods in the market. It is an additional revenue generated from a given set of an output.

Marginal revenue = ∆TR/∆Q

This formula represents change in total revenue with respect to change in quantity produced.

• Profit maximization goal : It is main aim of any firm and therefore it is also an objective of profit maximization firm.It help to run business properly and smoothly.

For perfect competition firm profit maximization level is

MR=MC (It means it is a level of output where firm is earning maximum profit)

• Marginal profit : It means the change in profit with resultant change in an output level.

Marginal profit= ∆π/∆Q

This formula shows that there is a change in profit with respect to change in quantity produced.