upward-sloping part of its short-run average total cost curve Diminishing (marginal) returns is a short-run concept since there must be a fixed input. Diseconomies of scale is a long-run concept since all inputs must be variable In long run, there are no fixed costs TFC= the same for all amounts of output and labour (doesn’t change!) TVC= wage rate x number of workers (set wage for each worker) TC= TFC + TVC MC= change in TVC/ change in output AFC= TFC/Q AVC= TVC/Q ATC= AFC + AVC Chapter 12 A firm in a perfectly competitive industry cannot influence price T o Firms are price takers The industry demand curve in a perfectly competitive industry is horizontal F o Individual firm demand curve is horizontal o Industry demand curve is downward sloping The objective of the firm in a competitive industry is to maximize revenue F o Goal is to maximize economic profit Firms will incur an economic loss in the long run but not the short run F o Will incur a loss in the short run (loss equal to TFC) but not the long run because the firm can just leave the market and go somewhere else o In short run, cannot leave market, can only temporarily shut down at the point where price (marginal revenue) is at minimum point on AVC curve At prices below minimum ATC, a firm will always shut down F o If the price is below ATC, but still above AVC, better to continue producing because you are minimizing your losses (the gain in producing is covering part of TFC that you would otherwise have to face the whole thing if you shut down) The supply curve of a perfectly competitive firm gives the quantities of output supplied at alternative prices as long as the firm earns economic profit F o As long as price > minimum AVC o This is because for a firm to earn economic profits, price must be greater than ATC (not just AVC because will still be making a loss if in between the two curves) In long-run equilibrium, each firm in a perfectly competitive industry will choose the plant size associated with minimum long-run average cost T o Otherwise, the firm is driven out of business by lower-cost firms
Suppose a perfectly competitive industry is in long- run equilibrium when there is an increase in demand. As new firms start entering the industry, the output of each existing firm will increase F o As new firms enter, supply shifts rightward, price falls, and output of each existing firm decreases (falls because now there are more firms in the market so the demand for each firm will decrease, more competitive) Suppose a perfectly competitive industry is in long-run equilibrium when there is a permanent increase in demand. In the short run, firms will earn an economic profit T o Price rises above ATC, creating economic profit Resource use is efficient as long as marginal benefit is greater than marginal cost F o Efficient when MB=MC A perfectly competitive industry: o Has a downward-sloping industry demand curve o Perfectly elastic demand curve for each individual firm o
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