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15 Perfect Competition 2

15 Perfect Competition 2 - Perfect Competition 2 12:00 AM...

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Perfect Competition 2 2/18/11 12:00 AM Review If P>ATC, then firm is profitable If P=ATC, then firm is breaking even If P<ATC, then firm is incurring a loss What should a firm incurring losses do? Short run: o Continue operating even though firm is incurring a loss o Shutdown operations because of market conditions Long run o Exit the industry due to market conditions A key difference : o If shut down in SR, firm must still pay fixed costs, cannot exit industry right away o If exit in long run, zero costs The Irrelevance of Sunk Costs Sunk cost : a cost that has already been committed and cannot be recovered It should be irrelevant to decisions FC is a sunk cost: The firm must pay its fixed costs whether it produces or shuts down A Firm’s Short-Run Decision when incurring a loss Benefit of operating: revenue gain= TR Cost of operating: cost=VC (firm must still pay FC) So, operate if benefit> loss, i.e. TR>VC Divide both sides by Q So, firm’s decision rule is
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15 Perfect Competition 2 - Perfect Competition 2 12:00 AM...

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