Seller's Choice Part 3

Economic Profits

- If economic profits are positive--> adjustment stops when economic profits are no longer being learned. - If economic profits are negative--> adjustment stops when economic profits reach zero (no more losses) - Economic profits tend toward-zero in the long run. If you earn economic profits in the long run, that means that you're doing as well running this business as in your next best alternative.

Entry decreases your demand and your profits

- New competitors will enter profitable markets. The cost-benefit principle tells us that it's worth entering market if the benefit exceeds the costs. - Firms will enter a new market if they expect to earn a positive economic profit, which occurs when the price exceeds the average cost. - New competitors make the market less profitable. - When new firms enter the market: - Market supply shifts out - Equilibrium price falls - Each firm's marginal revenue decreases

In the long run,

- The equilibrium price is always equal to the minimum average total cost​ (ATC). - Economic profits are zero in the long-run equilibrium.

Exit Increases your demand and your profits

- There's a flip side to this too. Just as the prospect of earning profits lures new firms to enter a market, the prospect of losses drives existing competitors to exit your market. - Firms will exit the market, if they expect to earn a negative economic profit, which occurs if the price is less than the average cost. - When existing firms exit the market: - Market supply shifts in. - Equilibrium price increases. - Marginal revenue and individual demand shifts up. - Firms sell a larger quantity and make higher profits. - Free exit ensures industries won't remain unprofitable in the long-run. The process of unprofitable businesses leaving the market continues until the market is not longer unprofitable. This occurs when the economic profits enjoyed by incumbent businesses rise to zero.

Key notes to remember

- Throughout this course, whenever you see the word "profit", I want you to read it as "economic profit.". Indeed, whenever you hear an economist talk about profits you can safely assume that that they mean economic profits. Likewise, when you see the word "costs," continue to think about them as including both explicit financial costs and implicit opportunity costs. - Note that if a firm is earning accounting profits just equal to the implicit opportunity costs, its economic profit is zero. Zero economic profit doesn't mean the firm is in trouble or going bankrupt. It just means that it is not doing any better here compared to the next best alternative. We sometimes call this making "normal profits". - Market producer surplus is the area above the supply curve and below the price. - If the variable inputs a firm needs to expand production are easily available, then supply will be more elastic. - The price elasticity of supply is typically larger when you're looking over a longer time horizon. - Free entry pushes economic profits down to zero in the long-run. New firms all continue to enter as long as economic profits are positive, with each additional competitor pushing profits down a bit further. And so the process continues, until there is no longer any incentive for new businesses to enter your market. This occurs when economic profits available to entrants fall to zero.( equilibrium price becomes equal to the break-even price). - A change in supply does not lead to a change in demand in the long run. - A change in demand leads to a change in supply in the long run. --The point is, whether or not it makes sense to launch this business depends on your opportunity costs. You need to apply the opportunity cost principle: beyond the explicit financial costs, you'll also need to account for the most implicit opportunity costs of running a business.

Practice Problem #4

A perfectly competitive firm has the following cost​ functions:Total​ cost: ​​, Marginal​ cost: ​, and it faces a market price of​ $900 per unit. The average and total cost curves are shown in the figure. At the profit-maximizing level of​ output, producer surplus is​ _______ and the​ firm's profits are​ _______. Correct Answer: $16,000, $6,000 (the profit maximizing output is such that MC=P so 100+20q=900, which yields q=40. Profit is total revenue minus total cost. When q=40, profit=40900-(10,000+10040+10*1,600)=6,000. Producer surplus is profit + FC, so PS=16,000.)

Practice Problem #2

Accounting profits at a firm's economic profit break-even point are ________. Correct Answer:positive (Remember that in economics, we consider profit to be generally defined as economic profit. Thus, when breaking even, economic profit is equal to zero. Given that implicit costs exist, this means that accounting profit (which doesn't include implicit costs) must be positive.) - Note that since fixed costs FC do not depend on the quantity produced, the quantity that maximizes profit also maximizes producer surplus. An important consequence of the difference between profit and producer surplus is that a firm may operate in the short run win negative profit, but it will never operate with a negative surplus. If the firm is operating with a negative producer surplus that means that the price is operating below the marginal cost (each unit costs more to produce than it sells for).

Practice Problem #14

Assume the market for tea is perfectly competitive and in the long run equilibrium. Suppose the price of coffee, a substitute for tea, increases. What will happen to the tea market as we move to the new long run equilibrium? Market quantity will ______________; market price will ______________; and firms' profits will ______________ Correct Answer:Increase; not change; not change

Practice Problem #15

Consider a competitive market initially in the long-run equilibrium. What are the long-term effects of the following change? A decrease in variable costs in the long run will cause the equilibrium price to ______________ and the equilibrium quantity in the market to ______________. Correct Answer:Decrease; increase by more than in the short run

Practice Problem #11

Consider a firm that faces the total cost and the marginal cost . Given this information, what is the lowest price at which the firm will stay in the market in the long-run? Correct Answer: $12 (ATC=q+36/q. The lowest price at which the firm will stay in the market is Min ATC (break even price). ATC reaches its minimum when it intersects MC: MC=ATC if 2q=q+36/q which yields q=6. Plugging that quantity into ATC or MC yields Min ATC=12.)

Change in fixed costs

Consider a market in the long run equilibrium. If fixed costs increase, it leads to an increase average cost, but not marginal cost. As a result, nothing changes in the short run in market. However, economic profits are reduced, and the typical firm is no earning economic losses. As we move to the long run, some firms leave, so the market supply shifts in. Thus the equilibrium price increases, and the firms's economic losses become smaller. That process continues until firms are no longer making a loss. In the new long-run equilibrium, price is higher, there are fewer firms, and the market quantity is lower than the initial long-run equilibrium.

Practice Problem #10

Firm entry into a competitive market will cause the market ______________ to ______________. Correct Answer: Supply; increase

Practice Problem #7

If the elasticity of supply of TV sets is equal to​ 3, then a 10 percent increase in the price of a TV will Correct Answer: Increase the quantity supplied by 30.0 percent.

Forgone Interest

If you don't invest your funds in this start-up, how much annual interest will you earn by investing it elsewhere.

Forgone Wages

If you don't launch this start-up, how much will you earn pursuing your next best career option

Practice Problem #12

In the long-run equilibrium for a perfectly competitive​ industry, Correct Answer: - average total costs of production are minimized. - the firm's economic profits are zero. - there is no entry or exit.

Practice Problem #9

In the​ figure, the price elasticity of supply at any given quantity is Correct Answer:equal to one on each of the three supply curves.

Practice Problem #6

On most days the price of a rose is​ $1 and 80 roses are purchased. On​ Valentine's Day the demand increases so that the price of a rose rises to​ $2 and 320 roses are purchased.​ Therefore, the price elasticity of supply of roses is about: Correct Answer: 1.8

Producer Surplus

Producer surplus describes the gan a producer gets form selling something at a higher price than necessary for them to want to supply the item, which is its marginal cost.

Implicit opportunity cost

The cost that a business bears by being in business and not in another business. It is the profit could be earned elsewhere. It is the opportunity costs (the entrepreneur's time and money).

Explicit Financial Costs

The costs that a business pays by writing a check or paying costs. Examples: all the money that leaves your business, including rent, wages for your employees, and the cost of your raw materials.

Practice Problem #8

The demand for corn increases. As a​ result, the price of corn will​ ______, and the less elastic the supply of​ corn, the​ ______ will be the effect on the price. Correct Answer: rise, greater

Practice Problem #13

The figure shows the supply and the demand for a good​ (left) and the cost curves of an individual firm in this market​ (right). Assume that all firms in this​ market, including the potential​ entrants, have identical cost curves.​ Initially, the market is in equilibrium at point A. In the short run, firms are making _______ profits; As the market moves to the new long run equilibrium, firms will _______ so supply will _______ until the equilibrium price is equal to ​ _______. Correct Answer: positive; enter; increase; $2

Long-run

The horizon over which all costs are avoidable and new firms may enter the marker or existing firms may exit. (what the long-run is depends on the industry).

Short-run

The horizon over which some costs are sunk, and the number of firms cannot change.

Practice Problem #5

The total producer surplus in the entire market is given by the​ ______. Correct Answer:sum of all the individual​ sellers' producer surplus

Accounting Profit

The total revenue a business receives, less its explicit financial costs.

Change in Variable Costs

We can also examine a case in which variable costs change. Suppose variable costs rise. It leads to an increase in average cost, and an increase in marginal costs-- they both shift up, such that the new marginal cost intersects the new average cost at its minimum. Since marginal cost shifts up (or "in") while the marker price is still the same as before because nothing has changed at the market level), each firm produces a lower quantity than before and are making negative profits--the price is now below the minimum of the average cost. As we move to the long-run, firms begin to exit. This shifts market supply in, which leads to an increase in market price so that firm's losses shrink. Firms will continue to leave, the price will continue to rise and the remaining firm's losses will continue to get smaller, until the price is equal to the minimum of the new average cost.

Practice Problem #1

When a firm earns zero economic profits, which of the following is correct? A. The firm has a positive accounting profit.

Practice Problem #3

Which of the following statements characterizes the relationship between (Economic) Profits and Producer Surplus? Correct Answer:Producer Surplus is equal to Profits plus Fixed Costs

Economic Surplus

the respective gains that a consumer or producer gets within an economic activity and is the combined benefit.

Economic Profit

total revenue minus total cost, including both explicit and implicit costs