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Shut down point and profit
The document contains examples and explanations of microeconomic concepts related to firm behavior including: 1. How a competitive firm determines its profit-maximizing quantity where marginal revenue equals marginal cost. 2. How the marginal cost curve determines the firm's supply decision - if price is above marginal cost, the firm will increase output. 3. The difference between a firm's short-run decision to shutdown if price is below average variable cost, versus its long-run decision to exit the market if price is below average total cost.
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Shut down point and profit
- 1. Bellringer On slates, 1. Identifythe firm’s short run variable costs 2. Identify the firm’s short run fixed costs 3.If 200 customers show up, what is their total revenue?
- 2. Exam review speed“dating” • Desks in 2 rows facing each other, 10 sets • 45 seconds each question, 17 minutes total
- 3. Have you everseen this? Why is this firm still open?
- 4. A C TI V E L E A R N I N GA C T I V E L E A R N I N G 22 Identifying a firm’s profitIdentifying a firm’s profit 4 Determine this firm’s total profit. Identify the area on the graph that represents the firm’s profit. Q Costs, P MC ATC P = $10 MR 50 $6 A competitive firm
- 5. A C TI V E L E A R N I N GA C T I V E L E A R N I N G 22 AnswersAnswers 5 profit Q Costs, P MC ATC P = $10 MR 50 $6 A competitive firm Profit per unit = P – ATC = $10 – 6 = $4 Total profit = (P – ATC) x Q = $4 x 50 = $200
- 6. A C TI V E L E A R N I N GA C T I V E L E A R N I N G 33 Identifying a firm’s lossIdentifying a firm’s loss 6 Determine this firm’s total loss, assuming AVC < $3. Identify the area on the graph that represents the firm’s loss. Q Costs, P MC ATC A competitive firm $5 P = $3 MR 30
- 7. A C TI V E L E A R N I N GA C T I V E L E A R N I N G 33 AnswersAnswers 7 loss MRP = $3 Q Costs, P MC ATC A competitive firm loss per unit = $2 Total loss = (ATC – P) x Q = $2 x 30 = $60 $5 30
- 8. With partner • UniversalWidgets • Has this cost structure: • Quantity ATC 500 200 501 201 Your current level of production is 500 and the units are already made A new customer wants to buy an additional widget for $450, would you sell it to them? Consider marginal costs in your decision, you must calculate total costs to find the answer ATC = TC/Q so TC=AVC*Q
- 9. With partner • UniversalWidgets • Has this cost structure: • Quantity ATC TC = Q*ATC 500 200 100,000 501 201 100,701 Your current level of production is 500 and the units are already made A new customer wants to buy an additional widget for $450, would you sell it to them? Consider marginal costs in your decision, you must calculate total costs to find the answer ATC = TC/Q so TC=AVC*Q
- 10. FIRMS IN COMPETITIVEMARKETS 10 P1 MR MC and the Firm’s Supply Decision At Qa, MC < MR. So, increase Q to raise profit. At Qb, MC > MR. So, reduce Q to raise profit. At Q1, MC = MR. Changing Q would lower profit. Q Costs MC Q1Qa Qb Rule: MR = MC at the profit-maximizing Q.
- 11. FIRMS IN COMPETITIVEMARKETS 11 P1 MR P2 MR2 MC and the Firm’s Supply Decision If price rises to P2, then the profit- maximizing quantity rises to Q2. The MC curve determines the firm’s Q at any price. Q Costs MC Q1 Q2 the MC curve is the firm’s supply curve.
- 12. FIRMS IN COMPETITIVEMARKETS 12 Shutdown vs. Exit • Shutdown: A short-run decision not to produce anything because of market conditions. • Exit: A long-run decision to leave the market. • A key difference: – If shut down in SR, must still pay FC. – If exit in LR, zero costs.
- 13. FIRMS IN COMPETITIVEMARKETS 13 A Firm’s Short-run Decision to Shut Down • Cost of shutting down: revenue loss = TR • Benefit of shutting down: cost savings = VC (firm must still pay FC) • So, shut down if TR < VC • Divide both sides by Q: TR/Q < VC/Q • So, firm’s decision rule is: Shut down if P < AVC
- 14. FIRMS IN COMPETITIVEMARKETS 14 The firm’s SR supply curve is the portion of its MC curve above AVC. Q Costs A Competitive Firm’s SR Supply Curve MC ATC AVC If P > AVC, then firm produces Q where P = MC. If P < AVC, then firm shuts down (produces Q = 0).
- 15. 15 Sunk Costs • Sunkcost: a cost that has already been committed and cannot be recovered • Sunk costs should be irrelevant to decisions; you must pay them regardless of your choice. • FC is a sunk cost: The firm must pay its fixed costs whether it produces or shuts down. • So, FC should not matter in the decision to shut down.
- 16. FIRMS IN COMPETITIVEMARKETS 16 A Firm’s Long-Run Decision to Exit • Cost of exiting the market: revenue loss = TR • Benefit of exiting the market: cost savings = TC (zero FC in the long run) • So, firm exits if TR < TC • Divide both sides by Q to write the firm’s decision rule as: Exit if P < ATC
- 17. FIRMS IN COMPETITIVEMARKETS 17 A New Firm’s Decision to Enter Market • In the long run, a new firm will enter the market if it is profitable to do so: if TR > TC. • Divide both sides by Q to express the firm’s entry decision as: Enter if P > ATC
- 18. FIRMS IN COMPETITIVEMARKETS 18 The firm’s LR supply curve is the portion of its MC curve above LRATC. Q Costs The Competitive Firm’s Supply Curve MC LRATC
- 19. Side by sidegraphs LR economic profits = 0
Editor's Notes
- #5 Rather than tell students that profit equals (P – ATC) x Q, this exercise requires students to figure it out for themselves. If this exercise is too easy for your students, you can replace it with lecture slides that appear at the end of this file.
- #6 The height of the rectangle is P – ATC, profit per unit. The width of the rectangle is Q, the number of units. The area of the rectangle = height x width = (profit per unit) x (number of units) = total profit.
- #7 Students that didn’t figure out the answer to the previous exercise should be able to get this one. If this exercise is too easy for your students, you can replace it with lecture slides that appear at the end of this file. Note that the statement “assuming AVC &lt; $3” is needed to prevent shut-down, i.e. to insure that the firm produces Q=30 instead of Q=0.
- #8 The height of the rectangle is ATC – P, loss per unit. The width of the rectangle is Q, the number of units. The area of the rectangle = height x width = (loss per unit) x (number of units) = total loss.
- #11 This slide is similar to Figure 1 in the chapter. I’ve omitted the AVC and ATC curves (which appear in Figure 1 in the chapter) because they are not needed at this point.
- #14 The shutdown rule, in plain English, says: If the cost of shutting down is less than the benefit, the firm should shut down.
- #15 In edit mode, it looks like the text boxes are on top of each other. But in presentation mode, the text boxes display only one at a time.
- #17 The decision rule for whether to exit says: If the cost of exiting is greater than the benefit, the firm should exit.
- #18 Similarly, a prospective entrant compares the benefits of entering the market (TR) with the costs (TC), and enters if the benefits exceed the costs.