Lecture_Microeconomics_Chapter9

Lecture_Microeconomics_Chapter9 - 9 Long-Run Costs and...

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Unformatted text preview: 9 Long-Run Costs and Output Decisions LONG-RUN COSTS AND OUTPUT DECISIONS We begin our discussion of the long run by looking at firms in three short-run circumstances: (2) firms earning economic profits, (4) firms suffering economic losses but continuing to operate to reduce or minimize those losses, and (6) firms that decide to shut down and bear losses just equal to fixed costs. SHORT-RUN CONDITIONS AND LONG-RUN DIRECTIONS breaking even The situation in which a firm is earning exactly a normal rate of return. Example: The Blue Velvet Car Wash MAXIMIZING PROFITS TABLE 9.1 Blue Velvet Car Wash Weekly Costs TOTAL FIXED COSTS ( TFC ) TOTAL VARIABLE COSTS ( TVC ) (800 WASHES) TOTAL COSTS ( TC = TFC + TVC ) $ 3,600 1. Normal return to investors $ 1,000 1. 2. Labor Materials $ 1,000 600 Total revenue ( TR ) at P = $5 (800 x $5) $ 4,000 2. Other fixed costs (maintenance contract, insurance, etc.) 1,000 $ 1,600 Profit ( TR - TC ) $ 400 $ 2,000 SHORT-RUN CONDITIONS AND LONG-RUN DIRECTIONS Graphic Presentation FIGURE 9.1 Firm Earning Positive Profits in the Short Run SHORT-RUN CONDITIONS AND LONG-RUN DIRECTIONS MINIMIZING LOSSES operating profit (or loss) or net operating revenue Total revenue minus total variable cost ( TR - TVC ). In general, If revenues exceed variable costs, operating profit is positive and can be used to offset fixed costs and reduce losses, and it will pay the firm to keep operating. If revenues are smaller than variable costs, the firm suffers operating losses that push total losses above fixed costs. In this case, the firm can minimize its losses by shutting down. SHORT-RUN CONDITIONS AND LONG-RUN DIRECTIONS Producing at a Loss to Offset Fixed Costs: The Blue Velvet Revisited TABLE 9.2 A Firm Will Operate If Total Revenue Covers Total Variable Cost CASE 1: SHUT DOWN CASE 2: OPERATE AT PRICE = $3 Total Revenue ( q = 0) $ Total Revenue ($3 x 800) $ 2,400 Fixed costs Variable costs Total costs + $ $ 2,000 2,000 Fixed costs Variable costs Total costs + $ $ 2,000 1,600 3,600 Profit/loss ( TR - TC )- $ 2,000 Operating profit/loss ( TR - TVC ) $ 800 Total profit/loss ( TR - TC )- $ 1,200 SHORT-RUN CONDITIONS AND LONG-RUN DIRECTIONS Graphic Presentation FIGURE 9.2 Firm Suffering Losses but Showing an Operating Profit in the Short Run SHORT-RUN CONDITIONS AND LONG-RUN DIRECTIONS ATC = AFC + AVC or AFC = ATC - AVC = $4.10 - $3.10 = $1.00 Remember that average total cost is equal to average fixed cost plus average variable cost. This means that at every level of output, average fixed cost is the difference between average total and average variable cost: As long as price (which is equal to average revenue per unit) is sufficient to cover average variable costs, the firm stands to gain by operating instead of shutting down. SHORT-RUN CONDITIONS...
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This note was uploaded on 03/30/2008 for the course ECON 2005 taught by Professor Zirkle during the Spring '07 term at Virginia Tech.

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Lecture_Microeconomics_Chapter9 - 9 Long-Run Costs and...

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