Econ 101-Perfect Competition

Econ 101-Perfect Competition - Perfect Competition - some...

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Perfect Competition -- some important points Please make sure that you understand the following very clearly: Loss minimization and shutdown rule A firm under perfect competition can produce the optimal output, but it doesn’t guarantee profits.  A firm can  (1) make profits, TR > TC (2) break even, TR = TC and even (3) make a loss TR < TC.  It all depends on the  size of the average costs relative to the price. Loss-making firm: Suppose that P < ATC at the level of output at which MR = MC. The firm will make a loss.  The question is,  will the firm continue operations? To determine this, we have to compare the firm's loss if it stays in business  with its loss if it shuts down. If the firm decides to shut down, its revenue will equal zero and its costs will  equal its fixed costs. (Remember, fixed costs must be paid even if the firm shuts down.)  Thus, the firm receives an economic loss equal to its fixed costs if it shuts down.  It will stay in business in the short run even if it receives an economic loss, as long as its loss is less than its  fixed costs. This will occur if the revenue received by the firm is large enough to cover its variable costs and  some of its fixed costs.  In mathematical terms, this means that the firm will stay in business as long as:  TR = P x Q > TVC Dividing both sides of the above expression by Q, we can write this condition in an alternative form as:  P > AVC  The firm will stay in business if the price is greater than average variable cost; the firm will shut down if the 
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This note was uploaded on 03/27/2008 for the course ECON 101 taught by Professor Brentkreider during the Spring '07 term at Iowa State.

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Econ 101-Perfect Competition - Perfect Competition - some...

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