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October 24/29 Lecture Notes EC 110

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University of Alabama
EC 110
Kent Zirlott

Key: Examples Formula Emphasis Definition Notes Reference 1) Characteristics of Perfect Competition a) 1) Many buyers and many sellers b) 2) The goods offered for sale are largely the same c) 3) Firms can freely enter or exit the market i) 4) Because of 1 and 2, each buyer and seller is a price taker (1) Price Taker- Takes the price as given d) 5 ) Marginal Revenue is equal to price i) Straight line on a graph 2) The Revenue of a Competitive Firm a) Average Revenue (AR) = Total Revenue / Quantity = Price b) Marginal Revenue (MR) = Change in Total Revenue / Change in Quantity 3) Profit Maximization a) If Marginal Revenue is > Marginal Cost, the increase quantity to raise profit b) If Marginal Revenue is < Marginal Cost, the reduce quantity to raise profit c) You maximize profit where Marginal Cost = Marginal Revenue d) The Marginal Cost curve is the firms supply curve 4) Stay Open vs. Shutdown vs. Exit a) Stay Open: A short-run decision to remain open and continue to produce when Price is less than ATC but greater than AVC. Still produce where Marginal Cost = Marginal Revenue even when making a loss. b) Shutdown: A short-run decision not to produce anything because of market conditions i) Revenue loss = Total Revenue ii) Benefit: Cost savings = Variable costs (still must pay fixed costs) iii) Should shut down if Total revenue < Variable Costs iv) Divide both sides by Q: (Total Revenue/Quantity) < (Variable Costs / Quantity) v) Should shut down if P < AVC vi) Hope that market gets better c) Exit: A long-run decision to leave the market i) Cost of exiting: revenue loss = Total Revenue ii) Benefit: cost savings = Total Costs iii) Should shut down it Total Revenue < Total Costs iv) Exit if Price < ATC v) The firms Long Run supply curve is the portion of its Marginal Cost curve above the LRATC d) Key Differences: i) If shut down is Short Run, must still pay Fixed Costs ii) If exit in Long Run, zero costs e) Sunk Costs: a cost that has already been committed and cannot be recovered i) Should be irrelevant to decision
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