ECON 2106 - CH 12 & 13 "Final Material"
4 Short Run Cases
1) Profit - Earn an Econ Profit 2) Break-Even 3)Incur a Large Loss (Shut-Down Case) 4) Incur a small loss (stay-open case)
The Firm's Supply Curve
A Firm's Supply Curve is derived from the Marginal Cost and Average Variable Cost with Market Prices on Y-axis and Quantity on X-Axis.
Price Takers
A Price Taker is a firm that cannot influence the market price because its production is an insignificant part of the total market.
The Shutdown Point
A firm's shut down point is the price and quantity at which it is indifferent between producing and shutting down. The shutdown point occurs at the price and quantity at which average variable cost is a minimum. At the shutdown point, the firm is minimizing its loss and its loss equals total fixed costs.
What is the Total Fixed Cost (TFC)
ATC - AVC Ave. Total Cost - Ave. Variable Cost
Total Variable Cost =
Average Variable Cost (AVC) x Quantity Produced
How does the firm maximize its profit in the short run? Why is this the case?
By producing at a quantity where the Marginal Revenue (MR) = Marginal Cost (MC); because the firm has produced ALL of the profitable units
Incur a loss (Cases 3 & 4) "Need To"
Compute: (ATC-AVC)*Q & (ATC-P)*Q Compare Both and see which is best option (least amt of $ loss)
What is a price taker?
Each firm in a perfectly competitive firm is a price taker, meaning they cannot influence the market price
Economic Loss
Economic Loss = Total Fixed Cost (TFC) + Total Variable Cost - Total Revenue
Entry and Exit
Firms respond to economic profit and economic losss by either entering or exiting a market.
Case 3) Large Loss(Shut Down) - Still have to pay ?
Fixed Costs (e.g. rent) even if they stop producing
When do firms in a competitive market make a short-run economic profit?
If demand increases
Economic Profit (or Loss)
In short-run equilibrium, although the firm produces the profit-maximizing output, it can end up making an economic profit, economic loss, or break even.
If demand for a good decreases, what happens to the price in the short run?
It falls, and, as long as the price remains above the firm's average cost, each firms produces less output
What does the market demand curve in a perfectly competitive industry look like?
It slopes downward
LRAC Curve
Long Run Average Cost Curve
Minimum Efficient Scale
Lowest Level of Output a firm can produce & have LRAC at its smallest possible value
What does a perfectly competitive firm's supply curve look like?
MC above the minimum AVC
P =
MR
Marginal Revenue (MR) formula
MR = (change in TR) / (change in Q)
Characteristics of PERFECT COMPETITION
Many Firms Identical Product Price Taker No Restrictions on entry into the market
Marginal Revenue
Marginal Revenue is the change in total revenue that results from a one-unit increase in quantity sold. In perfect competition, the firm's Marginal Revenue is equal to the market price.
MES
Minimum Efficient Scale
At the efficient quantity, do the total producer surplus and the total consumer surplus have to equal each other?
No, they do not.
If demand increases, do long-term firms make an economic profit?
No, they do not.
What does MR always equal in a perfectly competitive firm?
P
What is a shutdown point? What results from this?
P = AVC: the price and quantity at which the firm is indifferent between producing and shutting down; zero economic profit or break even
Firm SR Supply Curve
P must exceed Min AVC Output where P = MC or MR=MC "if it doesn't you are going into (shut-down) no output"
How Do Perfect Competitions Arise?
Perfect competition arises if the minimum efficient scale of a single produce is small relative to the market demand for the good or service.
Profit Break-even Case formula
Pie = (P-ATC)*Q
Total Revenue =
Price (P) x Quantity (Q)
What does price equal in perfect competition?
Price equals marginal revenue
Marginal Revenue =
Profit
Where do perfectly competitive firms in the long run produce?
at the minimum ATC
What happens to a market when firms are incurring persistent economic losses?
Some firms exit and the price rises
Economic Loss =
TFC + Q(AVC - P)
Two Methods of attaining Econ Profit
TR-TC Approach & MR-MC Approach
TR-TC is Maximized when
The Vertical Distance between the TR & TC curves is Maximized
Economic Profit
The difference from Accounting Profit is you include *"IMPLICIT COSTS" * in Econ Profit
Demand for the Firm's Product
The firm can sell any quantity it chooses at the market price. So the demand cue for the firm's product is a horizontal line at the market price, the same as the firm's marginal revenue curve. The demand for this particular firm's product is thus perfectly elastic and a perfect substitute for any other product in that firm's market.
The Firm's Decision
The goal of the competitive firm is to maximize economic profit, given the constraints it faces. To achieve its goal a firm must decide:
Short-Run
The short run is a situation in which the number of firms is fixed.
Total Revenue
Total Revenue = Price x Quantity Sold
On a graph, at what point is the output made?
When MC=MR
(MR>MC)
When Marginal Revenue exceeds Marginal Cost, profit occurs with one more unit of production and loss occurs with one less unit of production.
(MR=MC)
When Marginal Revenue is equal to Marginal Cost, economic profit is maximized and either an increase or a decrease in production decreases economic profit
(MR<MC)
When Marginal Revenue is less than Marginal Cost, profit occurs with one less unit of production and loss occurs with one more unit of production
Long-Run Quilibrium
When economic profit and economic loss have been eliminated and entry and exit have stopped, a competitive market is in long-run equilibrium.
Where do firms make an economic profit?
When the MR > ATC
When are resources used efficiently?
When we produce the goods and services people value most highly
MR - MC Approach (Profit Max at the point)
Where the MC curve intersects the MR curve from below
Do firms usually stay in a market whenever they cannot make an economic profit?
Yes, they usually stay in if they can break even
What kind of profit do perfectly competitive firms make in the long-run?
Zero Economic Profit
Total revenue
equals the price x units sold
What does the demand curve for a firm in perfect competition look like?
it is horizontal
In the long-run equilibrium in a perfectly competitive market, the firms produce at the ______ possible average total cost and the price equals the ______ possible average total cost.
lowest; lowest
In the short run, after an increase in demand firms _______ in the long run, after an increase in demand firms_______.
make an economic profit; make zero economic profit
What are factors that make up perfect competition?
many firms, same products, many buyers, no restrictions, no advantages for existing firms, and all buyers and sellers are well informed about prices
If firms in a market are incurring an economic loss, then as some exit, the price _____ and the surviving firms' economic losses_______.
rises; becomes smaller
Short-run market supply curve; what shape does it take?
shows the quantity supplies by all the firms in the market at each price when each firm's plant and the number of firms remains the same (the sum of the amounts supplied by each firm in the market at that price); it slopes upward
Marginal Revenue (MR)
the change in total revenue from a one-unit increase in the quantity sold (additional revenue)
What happens if P > AVC? What results from this?
the firm continues to product; economic profit
What happens if P < AVC? What results from this?
the firm shuts down; economic loss
What happens if the price is less than the firm's minimum ATC?
the firm suffers an economic loss
What happens with technological advances?
the firms' costs are lowered and their supply increases, firms that do not adapt the new technology incur economic losses, all firms make zero economic profit
What do consumers pay in a perfectly competitive market in the long run?
the lowest possible price that allows the firms to earn zero economic profit
What happens with a decrease in demand?
the price is initially lowered, some firms leave the market, and the price eventually rises to eliminate economic losses
What happens with an increase in demand?
the price is initially raised, new firms enter the market, and the price eventually falls to eliminate economic profit
What happens to market supply when a firm enters a market?
the supply increases
Why do firms continue to operate at zero economic profit?
they are still earning a normal profit and therefore they are earning the same profit that they could be earning elsewhere
What does a perfectly competitive's firm's supply curve look like for prices below the minimum average variable cost?
vertical at zero output
When does an efficient use of resources occur?
when making on person better off must make someone else worse off
What is the efficient level of output?
when the marginal social cost = marginal social benefit
When does perfect competition occur?
when the minimum efficient scale of a firm is small relative to demand
When will new firms want to enter a market?
when the new firms can make an economic profit