Chapter 8 - econ.docx

# When the price is less than avc for all positive

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- When the price is less than AVC for all positive quantities, the firm should stop producing and bear losses equal to fixed costs - This is why the bottom of the average variable cost curve is called the shutdown point o At all prices above it, marginal cost curve shows the profit maximizing level of output. At all prices below it, optimal short-run output is zero Shut down point: The lowest point on the average variable cost curve, when price falls below the minimum point on AVC, total revenue is insufficient to cover variable costs and the firm will shut down and bear losses equal to fixed costs - Shutting down is not the same as going out of business. In the short run, even a firm that shuts down keeps productive capacity intact – paying rent, insurance, and property taxes etc - A firm that shuts down does not escape fixed cost. o When demand picks up again, production resumes o Fixed cost is sunk cost in the short run, unavoidable whether the firm produces or shuts down Short run firm supply curve: a curve that shows how much in a firm supplies at each price in the short run; in perfect competition, that portion of a firms marginal cost curve that intersects and rises above the low point on its average variable cost curve Short-run industry supply curve: The sum of the marginal cost curves (above AVC) of all the firms in an industry The industry supply curve in the short run is the horizontal sum of the marginal cost curves (above AVC) of all the firms in an industry

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SLIDES – Short run to long run - In the short run, perfectly competitive firms can earn positive profits or negative profits - In the long run this is not possible. In the long run all PC firms must earn zero profit o Other words; the price will be pushed down to the minimum average cost (AC) o Remember this is the point where MC = AC o So in the long run we get P=MC=AC A firm earning positive profits in the short run:
- If firms in an industry earn positive economic profits (P>AC) then in the long run firms will enter this industry and existing firms may expand - Such entry and expansion will shift the supply curve out thus forcing prices going down - Firms will keep entering and expanding until profits = 0 If profits are positive, in the long run, existing firms will continue to expand as long as there are economies of scale to be realized (as long as costs are falling) - New firms will continue to enter as long as positive profits are being earned - In the long run, equilibrium price (P*) is = to long-run average cost, short run marginal cost & short run average cost. Profits are driven to zero o Long run average cost: minimum of short run average cost o P* = SRMC = SRAC = LRAC o SRMC = short run marginal cost o SRAC = short run average cost o LRAC = long run average cost - In the long run, departures and reductions in scale shift the market supply curve to the left, thereby increasing the market price until remaining firms just break-even – earn a normal profit From book - In the long run equilibrium, the firm produces q units of output per period and earns a normal profit - Point e = MC, MR, SRAC are all equal

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