lect11PC - 111 Perfect Competition Competitive Firms are...

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111 Perfect Competition Competitive Firms are Price Takers Firms maximize profits by Maximizing Revenues-Costs Max Pq - C(q) First order condition : P = C'(q) or P=MC Second order condition MC must be increasing at q* P = MR Demand Curve and Marginal Revenue Curve for Competitive Firm q $/q P = MR q $/q MC
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112 Firms will only operate at q* in the long run if economic profits are at least 0. Recall that costs include all opportunity costs so that 0 profits represents a normal rate of return on your investment. In the long run firms shut down whenever P< their minimum AC. If P is this low, profits are negative and the firm would be better off producing something else. When profits are negative, firms will exit. If profits are positive, firms can earn more in this industry than elsewhere in the economy firms will enter. P = MR q $/q MC AC 0 Profits P 2 q $/q MC AC Negative Profits P 1 Positive Profits
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113 In the short run, a firm will operate if Pq>VC, or P > AVC (Vc/q). In other words a firm must cover its variable costs in order to operate in the long run. This can be true even if P<AC (due to fixed costs). Thus in the short run, firms may still produce at a loss. The key in the short run is to make sure that you make more profits (or suffer fewer losses) by operating rather than shutting down. If the firm shuts down in the short run, q=0, Revenues=0, and the firm loses its fixed costs. The firm will operate if it can reduce its losses by selling some output. Profits will be increased from –FC if Pq is higher than the VC required to produce the q. Graphically the firm will shut down in the short run if P<P*. P 2 q $/q MC AC Negative Profits – Don’t Shut Down P 1 Positive Profits AVC P* Shut Down Price
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114 What these graphs ave shown is that a firm’s long run supply curve is given by its LRMC curve as long as P>=min AC, so that profits are zero or positive. The optimal output is given by the
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This note was uploaded on 09/15/2009 for the course ECON 420 K taught by Professor Bronars during the Fall '09 term at University of Texas at Austin.

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lect11PC - 111 Perfect Competition Competitive Firms are...

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