Lesson 10

Marginal revenue (MR)

The change in total revenue from selling one more unit of a product. = Change in TR/change in quantity = slope of TR curve The MR curve for a perfectly competitive firm is the same as its demand curve.

Average revenue (AR)

= TR/quantity always = to the market price. This equality holds because TR = P * Q and AR = TR/Q = (P * Q)/Q = P.

Supply curve of a firm in short-run

A higher price means more firms are willing to supply. The firm's MC curve is its supply curve only for prices at or above AVC. If price > breakeven (min. ATC), firms are profitable. This profit attracts new entrants, which will shift the supply curve to the right. Shut-down point is the the minimum point on a firm's AVC curve; if the price falls below this point, the firm shuts down production in the short run.

Profitability

Assume costs include opportunity costs (explicit + implicit) so that we are maximizing economic profits. Whether to produce depends on the price relative to minimum ATC: 1) Price > ATC => Profit 2) Price = ATC => the firm breaks even. 3) Price < ATC => Loss

Price-taking

Because a firm in a perfectly competitive market is very small relative to the market and because it is selling exactly the same product as every other firm, it can sell as much as it wants without having to lower its price. But if a perfectly competitive firm tries to raise its price, it won't sell anything at all because consumers will switch to buying the product from the firm's competitors. Therefore, the firm will be a price taker and will have to charge the same price as every other firm in the market. Thus, the demand curve of a perfectly competitive firm is horizontal. Although we don't usually think of firms as being too small to affect the market price, consumers are often in the position of being price takers.

Why would a firm want to enter an industry if the market price is only slightly greater than the break-even price?

Because of economic profit

Free entry and exit

Firms can enter and exit a market with no major obstacles, such as, Not necessary, but pretty common. Economic profit (A firm's revenues minus all its costs, implicit and explicit) leads to the entry of new firms. Economic losses (The situation in which a firm's total revenue is less than its total cost, including all implicit costs) lead to exit of firms.

Perfect competition

Implies that firms and consumers are price takers (buyers or sellers unable to affect the market price). No one can influence the market to sell it for more or less. Necessary conditions: 1) There must be many buyers and many firms, all of which are small relative to the market. 2) The products sold by all firms in the market must be identical. 3) There must be no barriers to new firms entering the market. A perfectly competitive firm will maximize profits where: 1) the difference between total revenue and total cost is the greatest. 2) marginal revenue = marginal cost. For a firm in a perfectly competitive market, price is equal to both AR and MR.

Short-run losses

In the short run, a firm experiencing a loss has two choices: 1. Continue to produce: A firm can reduce its loss below the amount of its total fixed cost by continuing to produce, provided that the total revenue it receives is greater than its variable cost. 2. Stop production by shutting down temporarily (most common scenario): Even during a temporary shutdown, however, a firm must still pay its fixed costs. Therefore, if a firm does not produce, it will suffer a loss equal to its fixed costs. This loss is the maximum the firm will accept. The firm will shut down if producing would cause it to lose an amount greater than its fixed costs.

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 AVC, while in the long​ run, a​ firm's exit point is the minimum point on the ATC curve.

Break-even price

Of a price-taking firm is the market price at which it earns a minimum profit (lowest profit). Occurs when its total cost equals its total revenue. If P is just high enough than ATC and if it chooses the Q where MR = MC, the firm will break-even.

Short-run vs Long-run industry supply curves

The long-run supply curve is always flatter (more elastic) than the short-run industry supply curve.

Marginal analysis

The profit-maximizing principle states that the optimal amount to sell is when MR = MC. For a firm in a perfectly competitive industry, price is equal to marginal revenue, or P = MR. So, we can restate the MR = MC condition as P = MC.

Long-run equilibrium in a perfectly competitive market

The situation in which the entry and exit of firms has resulted in the typical firm breaking even. A firm is in long-run eqbm. when the quantity supplied = quantity demanded, given that sufficient time has elapsed for entry into and exit from the industry to occur.

Why are firms willing to accept losses in the short run but not in the long​ run?

There are fixed costs in the short run but not in the long run.

When firms are price takers:

Total revenue (TR) is the total flow of income to a firm from selling a given quantity of output at a given price, less tax going to the government. = price of the product * quantity of product sold Profit = total revenue - total cost = =(P - ATC)*Q.