12 th lecture

12 th lecture - Economics 101 Lecture 12 The competitive...

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Unformatted text preview: Economics 101 Lecture 12 The competitive firms rule for choosing the profit-maximizing output level: P = MC A Note on the Firms Shut-Down Condition It might seem that a firm that can sell as much output as it wishes at a constant market price would always do best in the short run by producing and selling the output level for which price equals marginal cost. But there are exceptions to this rule. Suppose, for example, that the market price of the firms product falls so low that its revenue from sales is smaller than its variable cost at all possible levels of output. The firm should then cease production for the time being. By shutting down, it will suffer a loss equal to its fixed costs. But by remaining open, it would suffer an even larger loss. P = market price of the product Q = number of units produced and sold PxQ = total revenue from sales Shutdown rule: Cease production if PxQ is less than VC for every level of Q. Average Variable Cost and Average Total Cost Suppose that the firm is unable to cover its variable cost at any level of outputthat is, suppose that PxQ < VC for all levels of Q. Then P < VC/Q for all levels of Q, since we obtain the second inequality by simply dividing both sides of the first one by Q. VC/Q = average variable cost The firms short-run shut-down condition may thus be restated a second way: Discontinue operations in the short run if the product price is less than the minimum value of its average variable cost (AVC). Short-run shut-down condition (alternate version): P < minimum value of AVC Average total cost: ATC = TC/Q. Profit = total revenue total cost = PxQ ATCxQ = (P ATC) Q A firm can be profitable only if the price of its product price (P) exceeds its ATC for some level of output. A Graphical Approach to Profit- Maximization For Louisville Slugger, we have Employees per day Bats per day Variable Cost ($/day) Total Cost ($/day) Marginal Cost ($/bat) 80 1 40 24 104 0.60 2 100 48 128 0.40 3 130 72 152 0.80 4 150 96 176 1.20 5 165 120 200 1.60 6 175 144 224 2.40 7 181 168 248 4.00 Avg Var Cost ($/bat) 0.60 0.48 0.554 0.64 0.727 0.823 0.927 Avg Total Cost ($/bat) 1.28 1.169 1.173 1.21 1.28 1.37 2.60 Properties of the cost curves: 1. The upward sloping portion of the marginal cost curve (MC) corresponds to the region of diminishing returns.returns....
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This note was uploaded on 03/31/2008 for the course ECON 101 taught by Professor Hansen during the Spring '07 term at Wisconsin.

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12 th lecture - Economics 101 Lecture 12 The competitive...

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