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Lecture 12

Economics 1021A/B Lecture Notes - Lecture 12: Takers, Fixed Cost, Perfect Competition


Department
Economics
Course Code
ECON 1021A/B
Professor
Michael Parkin
Lecture
12

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CHAPTER 12 PERFECT
COMPETITION
WHAT IS PERFECT COMPETITION?
Many firms sell identical products to many buyers
There are no restrictions to enter the market
Established firms have no advantage over new ones
Sellers and buyers are well informed about prices
HOW PE RFECT COMPE TITION ARISES
Arises when the minimum efficient scale (smallest output at which the LRAC reaches the
lowest level) is small relative to the market demand for a good or service
PRICE TAKE RS
Price taker is a firm that cannot influence the market price because its production is an
insignificant part of the total market
Firms in perfect competitions are price takers
If one want to raise the price, no one will buy from them
If one wants to lower the price, they will run out of their small supply compared to the market
before they have an effect on market price
ECONOMIC PROFIT AND REVENUE
Remember that main goal is the maximize economic profit which is total revenue – total cost
TOTAL REVENUE
Price x output
On a graph, the total revenue will just a linear positive line as an increase in one unit will
increase the total revenue by the same amount each time
MARGIN AL REVENUE
The change in total revenue that results from one unit increase in quantity sold
In perfect competition, the firm's marginal revenue = market price
The graph is just a horizontal line because as quantity increases by 1 unit, marginal revenue
will be the same each time
DEMAND FOR THE FIRM'S PRODUCT
Demand for a firm's product is perfectly elastic
oSweater from this store is a perfect substitute for a sweater from another store
BUT THE MARKET DEMAND IS NOT PERFECTLY ELASTIC
oSweaters are not perfect substitutes for shirts
THE FIRM'S OUTPUT DECISION
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Answers the question of what quantity to produce so that economic profit is generated
Interest TC curve and the TR line (total revenue and cost vs quantity)
oWhen the TC > TR there is a loss
oWhen TC < TR there is a profit (TR-TC)
Economic profit vs quantity line
oAbove the x axis (positive) is an economic profit
oBelow is a loss
MARGIN AL ANALYSIS AND THE SUPP LY DECISION
Another way to find how much to produce in order to maximize profit
Compares MC and MR
Interest the MC and MR
When MC = MR, it is the profit maximizing point (how many to produce)
oThe price of the good is equal to the
When MR > MC, the marginal revenue exceeds the marginal cost
oRevenue of selling one more unit exceed the cost of producing it
oAn increase in output will increase economic profit
oBecause MR still exceeds the MC, that means although revenue is being generated
right now, by producing more, even though MC is being increased, the MR is still
bigger than MC and therefore there is still room before total profit is maximized
When MC > MR, the marginal cost exceed the marginal revenue
oRevenue from selling one more unit is less than the cost of producing it
oDecrease in output will increase economic profit
TEMPORARY SHUTDOWN D ECISION
When MC and MR equal each other it shows what quantity to produce in order to maximize
its profits
oHowever this does not mean that their maximum profit will exceed their average total
cost
When average total costs exceeds maximum profit (ATC>MC/MR) then that means that
there is an economic loss
When an economic loss happens, the firm must decide whether to shut down temporarily and
produce no output or to keep producing
LOSS COM PARISONS
A firms’ economic loss equals total fixed cost (TFC) plus the total variable cost (TVC) minus
the total revenue (TR)
Total variable cost equals the average variable cost multiplied by the quantity produced (TVC
= AVC x Q)
Recall total revenue is the price x quantity
Therefore economic loss = TFC + (AVC – P) x Q
If the firm shuts down, the quantity will be zero meaning that there will be no total variable
cost or revenue
oEconomic loss = TFC in this case
But if the firm produces there will be revenue made as well as total variable costs
oIf total variable costs (or AVC) exceeds the total revenue (price), then the firm should
just shut down instead because in addition to the TFC, by continuing to produce they
will also accumulate more variable costs
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THE SHUTD OWN POINT
A firm’s shutdown point is the price and quantity at which it is indifferent between
producing and shutting down
oOccurs where the AVC is at its minimum (where it intersects the MC curve and the
MR curve/price)
Indifferent because the AVC and the MR (price) are the same
oTherefore the economic loss at this point is just the TFC when the AVC is at its
minimum because (AVC-MR) = 0
oThe quantity produced at this point, maximizes economic profit (minimizes economic
loss)
When price falls below the minimum AVC point, then the firm should shut down temporarily
oBecause on top of the TFC, they are also paying more variable costs (price<AVC, so
TVC is added to the TFC)
oWhen they shut down, there will be nothing produced so the economic loss is still just
equal to the TFC
Economic loss is still minimized
At prices above the AVC but below the ATC curve, the firm produces the loss-minimizing
output and incurs a loss, but this loss is less than the total fixed cost
A FIRMS SUPPLY CURVE
The supply curve is derived from the firm’s marginal cost curve and the average variable
cost curves
When the price (MR line) exceeds the minimum average variable cost, the firm
maximizes profit by producing a larger quantity (the MR and MC curves intersect at a
larger quantity)
oMakes sense because the new MR will intersect the MC curve at a different point
each time
oIt moves up long its marginal cost curve
When the price is less than the minimum average variable cost point, then the firm should
shut down temporarily and produce 0 output
oIt only incurs a loss of the total fixed cost instead of also adding variable costs to
it (since AVC is higher than price at points where MR is lower than the minimum
average cost)
When the price equals the minimum average variable cost, the firm is indifferent and will
maximize profit either by temporarily shutting down/producing 0 output or by producing
the output at which the average variable cost is a minimum (shut down point)
oIf shut down, then the Q will be 0, meaning the economic loss will be the TFC
oIf the firm chooses to produce at this point then the AVC will equal the MR
(price)
When AVC – P, it will also equal 0 and will give an economic loss that
equals TFC
oTherefore, this is the shutdown point and the firm is indifferent between shutting
down and producing because it will give the same result of economic loss equally
TFC either way
The short run supply curve has nothing in between 0 and the quantity of the shutdown
point because it should not produce anything and shut down when the price is lower than
the AVC
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