at shutdown perfect compt

7/29/2019 At Shutdown Perfect Compt

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2001 Prentice Hall Business Publishing Economics: Principles and Tools, 2/e OSullivan & Sheffrin

Economic Profit

Profit per unit equalsrevenue per unit (orprice) minus cost perunit (or average totalcost).

($25 - $14) = 11

Total economic profit

equals:(price average cost)x quantity produced

($25 - $14) x 9 = $99


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Shut-down Decision

The firm should continue to operate ifthe benefit of operating (total revenue)exceeds the cost of operating, or totalvariable cost.

TR = (P x Q) must be greater than STVC =SAVC x Q, therefore,

If P > SAVC, the firm should continue tooperate

If P < SAVC, the firm should shut down


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The Shut-down Decision

When price drops to$9, the firm adjustsoutput down to 6

rakes per minute tomaintain P=SMC.

The firm suffers a loss, butsince price is greater thanaverage variable cost, thefirm continues to operate.

The average variablecost of producing 6rakes per minute is$6.


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The Shut-down Decision

The firms shut-down price is theprice at which the

firm is indifferentbetween operatingand shuttingdown.

At $5, P = SAVC. Above this price, the firm is better offcontinuing to produce at a loss. Below this price, thefirm is better off shutting down because it could notrecover its operating cost.


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Short-run Supply Curve

The firms short-run supply

curve shows the relationship

between the market price and thequantity supplied by the firm overa period of time during which one

inputthe production facilitycannot be changed.


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The Market Supply Curve

The short-run market supply curve shows therelationship between the market price and the quantitysupplied by all firms in the short run.


7/18 2001 Prentice Hall Business Publishing Economics: Principles and Tools, 2/e OSullivan & Sheffrin

A Market in Long-run Equilibrium

1. The quantity of the product supplied equals thequantity demanded

2. Each firm in the market maximizes its profit, giventhe market price

3. Each firm in the market earns zero economic profit,so there is no incentive for other firms to enter themarket

A market reaches a long-run equilibrium when threeconditions hold:



Short-run Supply Curve

For any price abovethe shut-down price,the firm adjustsoutput along its

marginal cost curveas the price levelchanges.

The short-run supply curve isthe firms SMC curve rising

above the minimum point on theSAVC curve.

Below the shut-down

price, quantitysupplied equals zero.




In short-run equilibrium, quantitysupplied equals quantity demanded

and each firm in the market maximizesprofit.

In addition to the conditions above, inlong-run equilibrium the typical firmearns zero economic profit so there isno further incentive for firms to enterthe market.




In long-run equilibrium, price equals marginal cost(the profit-maximizing rule), and price equals short-run average total cost (zero economic profit).



The Long-run Supply Curve for anIncreasing-cost Industry

An increasing-cost industry is an industryin which the average cost of productionincreases as the total output of the industryincreases.

The average cost increases as the industrygrows for two reasons:

Increasing input prices

Less productive inputs



Industry Output and AverageProduction Cost

Number of

Firms

Industry

Output

Rakes per

Firm

Typical

Cost for

Typical

Firm

Average

Cost per

Rake

50 350 7 $70 $10

100 700 7 84 12

150 1,050 7 96 14 The rake industry is an increasing-cost industry because

the average cost of production increases as the totaloutput of the industry increases.



Drawing the Long-run Market SupplyCurve

Each point on thelong-run supply curveshows the quantity of

rakes supplied at aparticular price (i.e.,at a price of $12, 100firms produce 700rakes).

The long-runindustry supplycurve is positively-sloped for an

increasing cost



An Increase in Demand and theIncentive to Enter

An increase in market demand puts upward pressure onprice. As price increases, there is an opportunity to earnprofit in the short run, and the industry attracts new firms.



The Long-run Effects of an Increasein Demand

In the short-run, firmsrespond to theincrease in demand

by adjusting output intheir existingproduction facilities,and the price adjustsfrom $12 to $17.


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The Long-run Effects of an Increasein Demand

In the long run, afternew firms enter,equilibrium settles at

$14. The new price is a

higher price than theprice before theincrease in demand

(increasing costindustry).


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Long-run Supply Curve for anConstant-cost Industry

In a constant-cost industry, firmscontinue to buy inputs at the same prices.

The long-run supply curve is horizontal atthe constant average cost of production.

After the industry expands, the industry

settles at the same long-run equilibriumprice as before.


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Long-run Supply Curve for the IceIndustry

In the long-run,

the price of icereturns to itsoriginal level.

An increase in thedemand for iceincreases the

price of ice to $5per bag.

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