Chapter 12
The firm should increase production from the current level.
A firm producing good Y recently increased monthly production from 1,500 units to 2,000 units. This had no impact on the market price of good Y. At the new production level of 2,000 units, the firm's average cost is $3.5 while its marginal cost of production is $4. The marginal revenue however is fixed at $5 for all levels of output. Jake Williamson is the operations head of the firm. Jake feels that, since the firm has the capacity, it should have increased production further to 2,500 units which would have maximized profits. On the other hand, Mathew Hayden of the market research team anticipates an increase in price to $5.5 in the near future. He therefore claims that the firm may not be maximizing economic profit in the short run even at 2,500 units. Jake and Mathew will most likely agree on which of the following?
Why would a firm produce in the short run while experiencing losses?
A firm would not shut down if by producing its total revenue would be greater than its total variable costs
If P < AVC shut down in the short run.
If price is below average variable cost for each unit produced and sold, the firm earns less revenue than the added variable costs it incurs (remember it only incurs variable costs if it produces). Therefore, the added revenue is less than the added cost, so losses are greater than just fixed costs.
upward-sloping
In a perfectly competitive industry with increasing average costs, the long-run supply curve will be
zero
In perfect competition, long-run equilibrium occurs when the economic profit is
Briefly discuss the difference between allocative efficiency and productive efficiency.
Productive efficiency pertains to production within an industry while allocative efficiency pertains to production across all industries.
can increase his profit by producing less output.
Suppose Farmer Lane grows and sells cotton in a perfectly competitive industry. The market price of cotton is $1.42 per kilogram, and his marginal cost of production is $1.61 per kilogram, which increases with output. Assume Farmer Lane is currently earning a profit. Can Farmer Lane do anything to increase his profit in the short run? Farmer Lane
not in equilibrium because farmers who were raising cage-free chickens were earning higher profits than farmers who raised chickens using more traditional methods. the equilbrium price to decrease and the equilibrium quantity to increase, as more firms enter.
The following questions are about long-run equilibrium in the market for cage-free eggs. Source: John Kell, "Dunkin' Donuts Considers Using Only Cage-Free Eggs," fortune.com, March 30, 2015. a. As described in the chapter opener, the market for cage-free eggs in 2015 was b. In the long run in the market for cage-free eggs, we would expect As the demand for cage-free eggs increases, other things equal, the price would increase so firms will earn higher profits. This will attract more farmers into the industry and cause the industry supply curve to shift to the right . If this is a constant-cost industry, the price will decrease in the long-run to what it was prior to the increase in demand.
there are fixed costs in the short run but not in the long run
What is the difference between a firm's shutdown point in the short run and its exit point in the long run? In the short run, a firm's shutdown point is the minimum point on the
A firm's marginal cost curve is equal to its supply curve for prices above average variable cost.
What is the relationship between a perfectly competitive firm's marginal cost curve and its supply curve?
Price is equal to both average revenue and marginal revenue.
What is the relationship between price, average revenue, and marginal revenue for a firm in a perfectly competitive market?
there are fixed costs in the short run but not in the long run
Why are firms willing to accept losses in the short run but not in the long run?
With many firms selling an identical product, single firms have no effect on market price
Why do single firms in perfectly competitive markets face horizontal demand curves?
economic profit
revenues minus all costs
sunk costs
costs that have already been paid and cannot be recovered; even if they haven't literally been paid yet, the firm is still obliged to pay them.
oligopoly
few firms, identical or differentiated products, low ease of entry, ex industries: manufacturing computers and automobiles
Marginal revenue (MR)
is the change in total revenue from selling one more unit of a product.
Average revenue (AR)
is total revenue divided by the quantity of the product sold
A firm is likely to be a price taker when
it represents a small fraction of the total market
monopolistic competition
many firms, differentiated products, high ease of entry, ex: clothing stores, restaurants
perfect competition
many firms, identical products, high ease of entry. ex industries: growing wheat, poultry farming. There are no barriers to new firms entering the market, many buyers and sellers, relatively rare
What determines entry and exit of firms in a perfectly competitive industry in the long run? In a perfectly competitive industry in the long run,
new firms will enter if existing firms are making a profit and existing firms will exit if they are experiencing losses.
monopoly
one firm, unique product, entry blocked, ex industries: first class mail delivery, providing tap water
Does the market system result in allocative efficiency? In the long run, perfect competition
results in allocative efficiency because firms produce where price equals marginal cost.
price-takers
they are unable to affect the market price. This is because they are tiny relative to the market, and sell exactly the same product as everyone else
Productive efficiency
when a good or service is produced at lowest possible cost.
Allocative efficiency
when every good or service is produced up the point where price equals marginal cost
