Chapter 12

deciding whether to shut down or to continue producing in the short run.

For any firm, whether total revenue is greater or less than variable cost is the key to deciding whether to shut down or to continue producing in the short run. As long as a firm's total revenue is greater than its variable cost, it should continue to produce no matter how large or small its fixed cost.

P<AVC. The firm should close temporarily.

If the price drops below average variable cost, the firm will have a smaller loss if it shuts down and produces no output. So, the firm's marginal cost curve is its supply curve only for prices at or above average variable cost.

decreasing-cost industries are

Industries with downward-sloping long-run supply curves

increasing-cost industries are

Industries with upward-sloping long-run supply curves

What is the difference betweem Allocative and Productive efficiency?

Productive efficiency pertains to production within an industry while allocative efficiency pertains to production across all industries

For a firm in a perfectly competitive market

price is equal to both average revenue and marginal revenue. 1- The profit-maximizing level of output is where the positive difference between total revenue and total cost is the greatest. 2- The profit-maximizing level of output is also where marginal revenue equals marginal cost, or MR = MC. P = MR. So we can restate the MR = MC condition as P = MC.

Total revenue equals

price times quantity (TR=P ×Q),

In the short run, a firm experiencing a loss has two choices:

1) Continue to produce 2) Stop production by shutting down temporarily

firms will supply all those goods that provide consumers with a marginal benefit at least as great as the marginal cost of producing them. This result holds because:

1) The price of a good represents the marginal benefit consumers receive from consuming the last unit of the good sold. 2) Perfectly competitive firms produce up to the point where the price of the good equals the marginal cost of producing the last unit. 3) Firms therefore produce up to the point where the last unit provides a marginal benefit to consumers equal to the marginal cost of producing it.

Illustrating When a Firm Is Breaking Even or Operating at a Loss

1- P>ATC, which means the firm makes a profit 2- P=ATC, which means the firm breaks even (its total cost equals its total revenue) 3- P<ATC, which means the firm experiences a loss

Competitive firm

A Perfectly Competitive Firm Cannot Affect the Market Price

Price taker.

A buyer or seller that is unable to affect the market price.

Sunk cost

A cost that has already been paid and cannot be recovered. In analyzing a firm's decision to shut down, we are assuming that its fixed costs are sunk costs.

Long-run supply curve

A curve that shows the relationship in the long run between market price and the quantity supplied. in the long run, a perfectly competitive market will supply whatever amount of a good consumers demand at a price determined by the minimum point on the typical firm's average total cost curve.

Economic profit

A firm's revenues minus all of its implicit and explicit costs.

Perfectly competitive market

A market that meets the conditions of (1) many buyers and sellers (2) all firms selling identical products, and (3) no barriers to new firms entering the market.

Productive efficiency

A situation in which a good or service is produced at the lowest possible cost.

Allocative efficiency

A state of the economy in which production is in accordance with consumer preferences; in particular, every good or service is produced up to the point where the last unit provides a marginal benefit to society equal to the marginal cost of producing it.

constant-cost industries.

Any industry in which the typical firm's average costs do not change as the industry expands production will have a horizontal long-run supply curve, like the egg industry.

perfect competition achieves allocative efficiency.

Because entrepreneurs in a competitive market system efficiently allocate labor, machinery, and other inputs to produce the goods and services that best satisfy consumer wants.

the relationship between total profit and average total cost

Profit=(P−ATC)×Q.

The Demand Curve for the Output of a Perfectly Competitive Firm

Suppose Bill Parker grows wheat on a 250-acre farm in Washington State. Farmer Parker is selling wheat in a perfectly competitive market, so he is a price taker. Because he can sell as much wheat as he chooses at the market price—but can't sell any wheat at all at a higher price—the demand curve for his wheat has an unusual shape: It is horizontal, as shown in Figure 12.1. With a horizontal demand curve, Farmer Parker must accept the market price, which in this case is $7 per bushel. Whether Farmer Parker sells 6,000 bushels per year or 15,000 has no effect on the market price.

Marginal revenue (MR)

The change in total revenue from selling one more unit of a product. MR=ΔTR/ΔQ.

Economic loss

The situation in which a firm's total revenue is less than its total cost, including all implicit costs.

Long-run competitive equilibrium

The situation in which the entry and exit of firms has resulted in the typical firm breaking even. The long-run average cost curve shows the lowest cost at which a firm is able to produce a given quantity of output in the long run. So, we would expect that in the long run, competition drives the market price to the minimum point on the typical firm's long-run average cost curve.

For any given price, we can determine from the marginal cost curve the quantity of output the firm will supply.

Therefore, a perfectly competitive firm's marginal cost curve is also its supply curve.

Average revenue (AR)

Total revenue divided by the quantity of the product sold.(AR=TR/Q) Therefore, AR=TR/Q=(P×Q)/Q=P.

Profit

Total revenue minus total cost. Profit = TR− TC. Profit=(P−ATC)×Q. To maximize his profit, Farmer Parker should produce the quantity of wheat where the difference between the total revenue he receives and his total cost is as large as possible.

profit per unit (or average profit)

equals price minus average total cost. Profit/Q=P−ATC

Average total cost (ATC)

equals total cost (TC) divided by the level of output (Q

marginal cost

is the increase in total cost resulting from producing another unit of output.

the marginal revenue curve for a perfectly competitive firm

is the same as its demand curve.