Chapter 8

What is a perfectly competitive market?

A market in which buyers and sellers are so many that no single one has any influence on market price and in which all the goods offered for sale are identical.

Average total cost equals marginal cost when

ATC is at its lowest point The marginal cost curve intersects the average total cost curve at the lowest point of the average variable cost curve. When marginal cost is below average variable cost, average variable cost falls with higher output.

The distance between the average total cost curve and the average variable cost curve is

FC/Q, which declines as quantity increases.

A key difference

If shut down is SR, Must still pay FC

Marginal revenue

MR = change in TR / change in Q (Change in total revenue from an additional unit sold

maximize profit for Q

MR=MC

A firm can earn a loss even if it produces at a price that is equal to its marginal cost.

True If a firm produces at an output level where price is below average total cost, then it will make an economic loss regardless of its marginal cost.

sunk cost

a cost that has already been committed and cannot be recovered should be ignored when making decisions you must pay them regardless of your choice in the short run, FC are sunk costs So, FC should not fatter in the decision to shut down

Exit

a long-run decision to leave the market

Shutdown

a short-run decision not to produce anything because of market conditions

Average total cost first declines

and then increases as more is produced.

Fixed costs

are constant in the short run for all levels of production.

Total costs

are the sum of all costs incurred by the firm in producing goods and services.

The distance between the average total cost curve and the average variable cost curve gets smaller

as production increases because fixed costs are an increasingly smaller proportion of total costs as production increases.

Total costs

can be written as the sum of fixed costs plus variable costs.

A firm's cost function

depends on its production function. In the simple example we study, the firm's production function shows how many hours of labor are needed to produce a particular quantity of output, given a certain fixed level of capital

The total cost per unit produced

is called the average total cost. It can be separated into two parts: average variable cost, defined as variable costs divided by quantity, and average fixed cost, defined as fixed costs divided by quantity.

MR = P for a Competitive Firm

is only true for firms in a competitive firm

The marginal cost

is the change in total costs as a result of producing one more unit of output.

When the marginal product of labor is increasing

it takes fewer workers to produce an additional unit of output; hence the additional cost of producing that unit of output (marginal cost) is decreasing.

when the marginal product of labor is decreasing

it takes more workers to produce an additional unit of output; hence the additional cost of producing that unit of output (marginal cost) is increasing.

Marginal cost

may rise or fall as production increases.

Ensure that the distance between average total cost and average variable cost gets

smaller as you increase the amount of production.

Ensure that the marginal cost curve cuts through

the average total cost curve and the average variable cost curve at their minimum points, and understand the reason for this.

If marginal revenue is less than marginal cost

the firm should decrease output

if marginal revenue is greater than marginal cost

the firm should increase its output

The long run

the period of time in which the firm can vary all inputs to production, including capital.

Put a small dip on the left-hand side of the marginal cost curve before

the upward slope begins. This allows for the possibility of decreasing marginal cost at very low levels of production.

Marginal cost is below average total cost when

total cost is falling and above average total cost when average total cost is rising.

The distance between the average total cost curve and the average variable cost curve is the amount of average fixed cost.

true Average total cost is the sum of average variable cost and average fixed cost. As such, the height of the average total cost curve is the sum of average variable cost and average fixed cost.

When marginal cost is greater than average variable cost, average variable cost must be rising.

true The marginal cost curve intersects the average variable cost curve at the lowest point of the average variable cost curve. When marginal cost exceeds average variable cost, average variable cost rises with higher output.

For competitive firms

- AR = P - MR = P

Perfectly competitive market

1. Market with many buyers 2. Trading identical products - Because of the first two: each buyer and seller is a price taker ( takes the price as given) 3. Firms can freely enter or exit the market.

Benefit of exiting market (in the long run)

= Cost savings = TC ( remember, FC= 0 in long run)

Cost of exiting market (in long run)

=Revenue Loss = TR

Average revenue

Ar= TR/ Q

AT Qa MC < MR so, increase q to raise profit

At W

Which of the following typically has a U-shaped curve?

Average total cost Fixed cost is constant so that average fixed cost declines as output increase. As a result of rising marginal cost, the average variable cost and average total cost curves rise with output where marginal cost exceeds the average costs. In other words, the average variable cost

Figure 8.5 Average Cost and Marginal Cost from a Numerical Example

Average total cost first declines and then increases as more is produced. Marginal cost is below average total cost when average total cost is falling and above average total cost when average total cost is rising. This relationship also holds between average variable cost and marginal cost. These cost curves are plotted from the data given in Figure 8.1.

should the firm shut down in the short run? Negative

Cost savings = VC

The breakeven point for a firm is the output level where

P = ATC A firm reaches a breakeven point when it earns zero economic profits, or when price equals average total cost.

should the firm shut down in the short run? Positive

Positive: Cost of shutting down = revenue loss = TR

Shut down if

TR<VC or P<AVC

Total revenue

TR= P * Q

Enter the market if

TR>TC or P>ATC

Exit the market if

TR>TC or P>ATC

Melodic Movements to derive the generic shapes of a firm's cost curves. These curves should have the following attributes:

The marginal cost (MC) curve should cut through both the average total cost (ATC) curve and the average variable cost (AVC) curve at their lowest points. The average fixed cost becomes very small as output increases. Therefore, the gap between average total cost and average variable cost gets smaller as more is produced. The marginal cost curve typically slopes downward at very low levels of output before sloping upward. The marginal cost and the average variable cost are also identical at one unit of output.

The Short Run

The period of time in which it is not possible to change all inputs to production; only some inputs, such as labor, can be changed.

The marginal cost curve, the average total cost curve, and the average variable cost curve are closely related. In the region in which the marginal cost is

higher than the average total (or variable) cost, average total (or variable) cost is increasing, and vice versa.

Variable costs

increase as more is produced.

In the long run, a firm can increase production by

increasing capital input Capital input is variable in the long run. When a firm increases capital input, it enters the long run when no inputs are fixed.