Ch. 7.3 & 7.4

What is average revenue?

total revenue divided by the quantity sold (AR = TR / q, OR [P x q] / q)

How do we determine whether a firm is experiencing an economic loss?

If at the profit-maximizing output level, q*, the price is less than the average total cost, the firm is incurring an economic loss.

Profit-maximizing level of output

A firm should always produce at the output lv. at which MR=MC.

Total Revenue (TR)

the product price times the quantity sold (TR = P x q)

A price-taking firm will tend to expand its output as long as price exceeds average variable cost and: A. its marginal revenue is less than the market price. B. its marginal revenue is positive. C. its marginal cost is less than the market price. D. its marginal revenue is greater than the market price.

C. its marginal cost is less than the market price. A price-taking firm will tend to expand its output as long as price exceeds average variable cost and its marginal cost is less than the market price. The reason? a) The fact that the marginal cost is less than the market price implies that the firm could increase its profits by expanding output, since the extra revenue of producing more units is greater than the extra cost of producing them. b) The fact that the price exceeds average variable cost implies that the firm does not confront a shut down decision. The shut down criterion can be summarized in the following three inequalities, all of which are equivalent. Shut down if Total Revenue < Total Variable Cost; or Average Revenue < Average Variable Cost; or if Price < Average Variable Cost.

Short-run supply curve

portion of the MC curve above the AVC curve.

How do we determine whether a firm is making zero economic profits?

If at the profit-maximizing output level, q*, the price is equal to average total cost, the firm is making zero economic profits; that is, the firm is covering both its implicit and explicit costs (making a normal rate of return.

Marginal Revenue (MR)

Increase in total revenue resulting from a one-unit increase in sales. (MR = change in TR / change in q)

How do we determine whether a firm is generating an economic profit?

The profit-maximizing output level is found by equating MR to MC at q. If at that output the firm's price is greater than its average total costs, it is making an economic profit.

Average Revenue (AR)

total revenue divided by the number of units sold (AR = TR / q)

What is total revenue?

total revenue is price times the quantity sold (TR = P x q)

What is marginal revenue?

the change in total revenue from the sale of an additional unit of output (MR = change in TR / change in q) In a competitive industry, the price of the good equals both the average revenue and the marginal revenue.

If a profit-maximizing firm finds that price exceeds average variable cost and marginal cost is greater than marginal revenue, it should: A. reduce output, but continue producing in the short run. B. not alter its production level since it is earning a profit. C. shut down. D. increase output.

A. reduce output, but continue producing in the short run. If a profit-maximizing firm finds that price exceeds average variable cost and marginal cost is greater than marginal revenue, it should reduce output, but continue producing in the short run. For a firm to maximize profits, it has to produce the quantity at which marginal revenue (or price) equals marginal cost. The rule implies that the firm should produce less units of output if the marginal revenue is below the marginal cost, that is if the cost saved by producing one less unit of output is greater than the revenue lost by reducing production by that unit.

Why does the firm maximize profits where marginal revenue equals marginal costs?

As long as the marginal revenue exceeds marginal costs, the seller should expand production, because producing and selling those units adds more to revenues than to costs; that is, it increases profits, However, if the marginal revenue is less than the marginal cost, the seller should decrease production.

A firm sells grapefruit in a perfectly competitive market at a price of $1.50 per pound. The firm's marginal revenue: A. cannot be determined from the information provided. B. equals $1.50. C. is greater than $1.50. D. is less than $1.50.

B. equals $1.50. A firm sells grapefruit in a perfectly competitive market at a price of $1.50 per pound. The firm's marginal revenue equals $1.50, which is the price. Marginal revenue (MR) is the change in total revenue resulting from selling one more unit. Since the perfectly competitive firm can sell as many units as it produces without affecting the price, for each additional unit sold, total revenue increases by the price. So, total revenue for 100 pounds of grapefruit sold is $150 (100X1.50); total revenue for 101 gallons sold is $151.50 (101x1.50). So, marginal revenue is the difference of $151.50 minus $150 = $1.50, which equals the price. In the case of a perfectly competitive firm, it does no matter if the calculation is made with 100 units or 10.000 units. The firm can sell any quantity at the market price.

If a perfectly competitive firm's marginal revenue was less than its marginal cost, A. it would raise its price in order to increase its profits. B. it would contract its output (but not raise its price) in order to increase its profits. C. it is currently earning economic losses. D. both a. and c. are true. E. both b. and c. are true.

B. it would contract its output (but not raise its price) in order to increase its profits.

A profit-maximizing firm in a perfectly competitive market will always produce a quantity of output that: A. minimizes the per-unit cost of production. B. is expected to maximize total revenue. C. maximizes the amount by which total revenue exceeds total cost. D. brings average total cost and price into equality.

C. maximizes the amount by which total revenue exceeds total cost. A profit-maximizing firm in a perfectly competitive market will always produce a quantity of output that maximizes the amount by which total revenue exceeds total cost. A firm in a competitive market, or for that matter in any market, tries to maximize profits, the difference between total revenues and total costs. Profit = Total Revenue (TR) - Total Cost (TC)

In perfect competition, at the firm's profit maximizing short run output, which of the following is true? A. It could be earning either economic profits or losses. B. Marginal revenue equals marginal cost. C. Price equals marginal cost. D. All of the other statements are true. E. Average revenue equals marginal revenue.

D. All of the other statements are true.

If a perfectly competitive firm is operating in the short run and seeks to maximize profit, the firm should: A. increase output whenever marginal revenue is less than marginal cost. B. choose the output where per-unit profit is greatest. C. increase output whenever marginal cost is less than average total cost. D. increase output whenever market price exceeds marginal cost.

D. increase output whenever market price exceeds marginal cost. If a perfectly competitive firm is operating in the short run and seeks to maximize profit, the firm should increase output whenever market price exceeds marginal cost. For a firm to maximize profits, it has to produce the quantity at which marginal revenue (or price) equals marginal cost. The rule implies that the firm should produce more units of of output if the price (or marginal revenue) exceeds the marginal cost, that is if the extra revenue of producing one more unit of output is greater than the extra cost of producing that extra unit. For example, if a grapefruit producing farm is at production level where its marginal cost is $1.20 per pound and its marginal revenue or price is $1.50 per pound, it should produce more pounds of grapefruits since profits would increase $0.30 per pound. The extra revenue of $1.50 more than covers the extra cost of $1.20, and there is an extra profit of $0.30 per pound

Assume a perfectly competitive firm sells its output for $250 per unit. At its current 2,000 units of output, marginal cost is $180 and increasing, and average variable cost is $160. Assuming it wants to maximize its profits, it should: A. shut down. B. maintain its current output rate. C. decrease output, but not shut down. D. increase output. E. There is not enough information to determine what the firm should do.

D. increase output. The firm should increase output, since by producing one more unit of output its total revenue would increase by $250, its marginal revenue or price, while its total cost would increase by $180, its marginal cost. That implies that profit would increase by $70 for each additional unit produced.

Why doesn't a firm produce when price is below average variable cost?

If the price falls below the average variable cost, the firm is better off shutting down rather than operating in the short run, because it would incur greater losses from operating than from shutting down.

For a perfectly competitive firm, which of the following is always true? A. Average Revenue = Demand only B. Price = Marginal Revenue only C. Average Total Cost = Marginal Revenue only D. none of the above E. Price = Marginal Revenue = Demand

E. Price = Marginal Revenue = Demand For a perfectly competitive firm, it is always true that price (p) equals marginal revenue (MR) equals demand (D). A firm's total revenue (TR) is equal to the quantity sold (q) times the price (p). For a perfectly competitive firm, the price is the same regardless of the quantity sold, since it can sell all output it produces at the market-determined price. For instance, if a dairy farm produces 1.000 gallons of milk per day and the gallon of milk sells for $ 3 dollars, total revenue for the milk producer is 1.000 x $ 3 = $ 3.000. The price of $ 3 has to be taken as given, assuming that the milk market behaves as a perfectly competitive market of many sellers and buyers of an identical product ("a gallon of milk is a gallon of milk"). Marginal revenue (MR) is the change in total revenue resulting from selling one more unit. Since the perfectly competitive firm can sell as many units as it produces without affecting the price, for each additional unit sold, total revenue increases by the price. Thus, marginal revenue equals the price, which also happens to be the demand curve, represented by a horizontal line (perfectly elastic demand). In the dairy farm example, total revenue for 1.000 gallons sold is $ 3.000; total revenue for 1.001 gallons sold is $ 3.003. So, marginal revenue is the difference of $ 3.003 minus $ 3000 = $ 3, which equals the price (see graph below). The demand curve of the milk farm is a horizontal line at p = $ 3.0 The relevant equations are: TR = p x q MR = Δ TR / Δ q

For a perfectly competitive firm, average revenue is: A. equal to marginal cost at all levels of output. B. equal to marginal revenue at all levels of output. C. equal to price at all levels of output. D. characterized by both a. and b. E. characterized by both b. and c.

E. characterized by both b. and c. Statement B is true: For a perfectly competitive firm, average revenue is equal to marginal revenue at all levels of output. Statement C is true: For a perfectly competitive firm, average revenue is equal to price at all levels of output.

Short-run market supply curve

horizontal summation of the individual firm's supply curves in the market.