Profit equals total revenue (TR) minus total cost (TC) 1. Profit = TR – TC 2. Profit = [(TR / Q) – (TC / Q)] x Q 3. Profit = (P – ATC) x Q ii. Area of rectangle (P – ATC) x Q = firm’s profit iii. Area of rectangle (ATC – P) x Q = firm’s loss 3. The Supply Curve in a Competitive Market a. The Short Run: Market Supply with a Fixed Number of Firms i. The quantity of output supplied to the market equals the sum of the quantities supplied by each of the individual firms b. The Long Run: Market Supply with Entry and Exit i. If firms already in the market are profitable, then new firms will have an incentive to enter the market 1. This entry will expand the number of firms, increase the quantity of the good supplied, and drive down prices and profits ii. If firms in the market are making losses, then some existing firms will exit the market 1. Their exit will reduce the number of firms, decrease the quantity of the good supplied, and drive up prices and profits iii. At the end of this process of entry and exit, firms that remain in the market must be making zero economic profit 1. Profit = (P – ATC) x Q a. An operating firm has zero profit if and only if the price of the good equals the average total cost of producing that good b. If price is above average total cost, profit is positive, which encourages new firms to enter c. If price is less than average total cost, profit is negative, which encourages some firms to exit d. The process of entry and exit ends only when price and average total cost are driven to equality iv. The level of production with lowest average total cost is called the firm’s efficient scale 1. Therefore, the long-run equilibrium of a competitive market with free entry and exit must have firms operating at their efficient scale v. In a market with free entry and exit, there is only o ne price consistent with zero profit— the minimum of average total cost 1.
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