THE FIRM AND ITS CUSTOMERS
Full Exam-Ready Explanation Notes
1. Introduction — Firms and Customer Demand
A firm must make two key decisions:
• What price to charge
• How much output to produce
These are examples of constrained choice problems, because firms must consider:
• customer demand
• production costs
• market competition
• technology and market conditions
Interaction Between Firms and Customers
This unit focuses on how firms interact with customers, particularly when firms sell differentiated
products.
Firms must anticipate how customers respond to prices when deciding:
• price
• production quantity
• advertising
• innovation investment
2. Firm Decisions
A firm’s decisions affect:
• production
• sales
• profits
Important firm decisions include:
• price setting
• output quantity
• advertising expenditure
• investment in technology
• hiring workers
In many models, firms choose price first, then determine the quantity they will produce and sell.
3. Pricing and Production Decisions
Firms choose a combination of:
Price (P)
Quantity (Q)
These determine:
• revenue
• costs
• profits
, Total Cost
Total cost depends on production cost per unit.
Formula:
Total Cost = Unit Cost × Quantity
TC = c × Q
Example:
If unit cost is $2:
TC = 2Q
Total Revenue
Revenue is the income from selling products.
Total Revenue = Price × Quantity
TR = P × Q
Profit
Profit equals revenue minus cost.
Profit = Total Revenue − Total Cost
π = TR − TC
Example:
π = (P × Q) − (2Q)
4. Isoprofit Curves
Isoprofit curves show combinations of price and quantity that generate the same profit.
Graph axes:
• horizontal axis → Quantity (Q)
• vertical axis → Price (P)
Properties of Isoprofit Curves
• Higher curves represent higher profit levels
• Firms prefer higher curves
• Curves slope downward
Explanation:
If price falls, the firm must sell more quantity to maintain the same profit.
Full Exam-Ready Explanation Notes
1. Introduction — Firms and Customer Demand
A firm must make two key decisions:
• What price to charge
• How much output to produce
These are examples of constrained choice problems, because firms must consider:
• customer demand
• production costs
• market competition
• technology and market conditions
Interaction Between Firms and Customers
This unit focuses on how firms interact with customers, particularly when firms sell differentiated
products.
Firms must anticipate how customers respond to prices when deciding:
• price
• production quantity
• advertising
• innovation investment
2. Firm Decisions
A firm’s decisions affect:
• production
• sales
• profits
Important firm decisions include:
• price setting
• output quantity
• advertising expenditure
• investment in technology
• hiring workers
In many models, firms choose price first, then determine the quantity they will produce and sell.
3. Pricing and Production Decisions
Firms choose a combination of:
Price (P)
Quantity (Q)
These determine:
• revenue
• costs
• profits
, Total Cost
Total cost depends on production cost per unit.
Formula:
Total Cost = Unit Cost × Quantity
TC = c × Q
Example:
If unit cost is $2:
TC = 2Q
Total Revenue
Revenue is the income from selling products.
Total Revenue = Price × Quantity
TR = P × Q
Profit
Profit equals revenue minus cost.
Profit = Total Revenue − Total Cost
π = TR − TC
Example:
π = (P × Q) − (2Q)
4. Isoprofit Curves
Isoprofit curves show combinations of price and quantity that generate the same profit.
Graph axes:
• horizontal axis → Quantity (Q)
• vertical axis → Price (P)
Properties of Isoprofit Curves
• Higher curves represent higher profit levels
• Firms prefer higher curves
• Curves slope downward
Explanation:
If price falls, the firm must sell more quantity to maintain the same profit.
