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Class03_19

# Class03_19 - the rectangle ABCD in the graph above • If...

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19/03/2008 Class Notes (cover part of Chapter 10 in the textbook) Class Outline Perfect Competition Perfect Competition Last time we considered the case of positive profits in equilibrium. What if there is a loss? q TC MC MR Profit 0 20 -20 1 25 5 10 -15 2 30 5 10 -10 3 37 7 10 -7 4 46 9 10 -6 5 57 11 10 -7 6 70 13 10 -10 If the firm shuts down it will make a negative profit of \$20. The loss is minimized when the firm produces 4 units of good. At q*=4 TR= \$40, TC=\$46, VC=26=\$(46-20) TR-VC=\$14 which partly pays the fixed costs!!! Recall : in short-run some costs are fixed, i.e., sunk. Hence, a firm in short run decides to operate by comparing the ATR (Average Total Revenue) to the AVC (Average Variable Costs): If TR VC ATR AVC q q = = Stay in business, indeed in the short-run the economic profit is positive! If TR VC ATR AVC q q = < = Shut down! 1

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Graphically At p*=10, q*=4 Economic Profit=q*(p*-AVC(q*))=\$14 which equals to the area of
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Unformatted text preview: the rectangle ABCD in the graph above. • If the price changes such that it becomes p*’< Min AVC the economic profit is negative and the firm is better off shutting off • If the price changes and it finally equates the Min AVC the economic profit is null and the firm is indifferent between staying or leaving the market! The min of the AVC is called “shut down point” . Graphically: AVC q*=4 q D f p*=10 \$ MC A B C D Min AVC 2 AVC(q*)=26/4 We can then trace out the short-run supply curve for a firm (in red in the graph above)! • A firm that operates in the short-run can still make a negative profit accounting for the fixed costs (blue area, in the graph below). q 1 * q 3 * q 2 * q \$ AVC MC q * q \$ MC AVC ATC 3 p 1 p 2 p 4 p* ( 0, p 4 ) (q*,p*) (q 1 *,p 1 *) (q 2 *,p 2 *) p* (q*,p*)...
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