ECN 121 Ch. 6

a tool for organizing a manager's thinking

short run v. long run

P=MC means (if no external costs or benefits)...

socially rational consumption, MB=MC

Short run rules to select best output level for a profit-maximizing firm

1) Expand output as long as price ≥ MC 2) Shut down (produce a quantity of zero) if P < minimum of the average variable curve

Why a firm might prefer to produce in the short run even if they are making losses

If the firm can cover their variable costs in the short run, then they can start to pay down some of their fixed costs by producing. If they shut down they must pay all of their fixed costs. If the firm can cover the variable costs they can use any excess revenue towards paying their fixed costs, which is a better outcome than shutting down in the short run.

relationship between marginal cost (MC) and average variable cost (AVC)

MC and AVC intersect at the lowest AVC

Expand production as long as...

P ≥ MC

relationship between market price (P), average total cost, and profitability

Profit = (P x Q) - (ATC x Q). A firm is said to be profitable is its revenue (P x Q) exceeds its total cost (ATC x Q)

Shut down production if...

TR < VC

Market supply curve is the horizontal sum of what?

The firm supply curves

Why are demand curves facing perfectly competitive firms horizontal?

There are many markets and they each sell the same thing, so if they wanted to charge more than current price, no one would buy from them

perfectively competitive market

a market in which no individual supplier has significant influence on the market price of the product

short run

a period of time in which at least one factor or production is fixed

long run

a period of time in which no factors of production are fixed

factor of production

a resource that doesn't get consumed as production happens

example of variable cost

company's payment to its employees

how to calculate total profit

profit = (P - ATC) x Q

equation for profit

profit = total revenue - variable cost - fixed cost

marginal cost

the increase in total cost that results from carrying out one additional unit of activity

A firm's supply curve is...

the portion of its MC curve above its AVC curve

fixed cost

the sum of all payments made to the firm's fixed factors of production

variable cost

the sum of all payments made to the firm's variable factors of production

average total cost (ATC)

total cost/total output

Even when a firm produces the level of output at which price equals marginal cost, it should shut down if its total revenue is less than its...

variable cost

law of diminishing returns

when some factors of production are held fixed, increased production of the good eventually requires even-larger increases in the variable factor