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Costs and Costs and supply. Perfect supply. Perfect
competitioncompetition
Lectures/DeianDoykov/International University/Foundation Year/Semester 1-2005
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Perfect competitionPerfect competitionPerfect competitionPerfect competition
“The real price of everything, what everything really costs to the man who wants to acquire it, is the toil and trouble of acquiring it”
Adam Smith. The Wealth of Nations
2 November 05
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Introduction to EconomicsIntroduction to Economics
3 October 05
Costs and supply. Perfect Costs and supply. Perfect
competitioncompetition Input and output. Costs and the choice of technique. Long run total, marginal and average costs. Returns to scale. Average cost and marginal cost.
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Introduction to EconomicsIntroduction to Economics
4 October 05
Costs and supply. Perfect Costs and supply. Perfect
competitioncompetition The firm’s short and long run output decisions. Short run costs and diminishing marginal returns. Short run and long run costs. Perfect competition and perfectly competitive firm.
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5 November 05
Costs and supply
Input and output
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Input and outputInput and output
Factors of production
Labor and capital used to produce goods
and services Production function
The set of all technically efficient
Techniques Technological progress An increase in output without increasing inputs.
6 November 05
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Costs and supplyCosts and supplyCosts and supplyCosts and supply
Economic cost versus Accounting cost
Economic cost (EC) Explicit costs plus implicit costs
Accounting cost (AC) Measures the explicit costs of operating a business
Explicit costs (Ex. C) The firm's actual cash payments for its inputs
Implicit costs (IC) The opportunity cost of nonpurchased inputs
Economic cost versus Accounting cost
Economic cost (EC) Explicit costs plus implicit costs
Accounting cost (AC) Measures the explicit costs of operating a business
Explicit costs (Ex. C) The firm's actual cash payments for its inputs
Implicit costs (IC) The opportunity cost of nonpurchased inputs
7 November 05
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Costs and supplyCosts and supplyCosts and supplyCosts and supply
Short-run costs Total cost
Short-run costs Total cost
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Costs and supplyCosts and supplyCosts and supplyCosts and supply
Short run
A period of time over which one or more factors of production is fixed; in most cases, a period of time over which a firm cannot modify an existing facility or build a new one Short-run average total cost (SATC)
Short-run total cost divided by the quantity of output, equal to AFC plus AVC. Short-run average variable cost (SAVC)
Variable cost divided by the quantity produced
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0
20
40
60
80
100
0 1 2 3 4 5 6 7 8
Output(Q)
01234567
TFC(£)
1212121212121212
Total costs for firm XTotal costs for firm X
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0
20
40
60
80
100
0 1 2 3 4 5 6 7 8
TFC
Output(Q)
01234567
TFC(£)
1212121212121212
Total costs for firm XTotal costs for firm X
11 November 05
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0
20
40
60
80
100
0 1 2 3 4 5 6 7 8
TFC
Output(Q)
01234567
TFC(£)
1212121212121212
TVC(£)
010162128406091
Total costs for firm XTotal costs for firm X
12 November 05
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0
20
40
60
80
100
0 1 2 3 4 5 6 7 8
TVC
Output(Q)
01234567
TFC(£)
1212121212121212
TVC(£)
010162128406091
TFC
Total costs for firm XTotal costs for firm X
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0
20
40
60
80
100
0 1 2 3 4 5 6 7 8
TVC
TFC
Diminishing marginalreturns set in here
Total costs for firm XTotal costs for firm X
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0
20
40
60
80
100
0 1 2 3 4 5 6 7 8
TVC
Output(Q)
01234567
TFC(£)
1212121212121212
TVC(£)
010162128406091
TFC
Total costs for firm XTotal costs for firm X
15 November 05
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0
20
40
60
80
100
0 1 2 3 4 5 6 7 8
TVC
TFC
Output(Q)
01234567
TFC(£)
1212121212121212
TVC(£)
010162128406091
TC(£)
12222833405272
103
Total costs for firm XTotal costs for firm X
16 November 05
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0
20
40
60
80
100
0 1 2 3 4 5 6 7 8
TCOutput
(Q)
01234567
TFC(£)
1212121212121212
TVC(£)
010162128406091
TC(£)
12222833405272
103
TVC
TFC
Total costs for firm XTotal costs for firm X
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0
20
40
60
80
100
0 1 2 3 4 5 6 7 8
TC
TVC
TFC
Diminishing marginalreturns set in here
Total costs for firm XTotal costs for firm X
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Short-run costsShort-run costs
Marginal cost= TC / Q
Marginal cost= TC / Q
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0
20
40
60
80
100
120
0 1 2 3 4 5 6 7
Deriving marginal costs
Q TC MC0 12 1 22 2 28 3 33 4 40 5 52 6 72 7 103
10 6 5 7122031
Costs (£)
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0
20
40
60
80
100
120
0 1 2 3 4 5 6 7
TC
Deriving marginal costs
Q TC MC0 12 1 22 2 28 3 33 4 40 5 52 6 72 7 103
10 6 5 7122031
Costs (£)
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0
20
40
60
80
100
120
0 1 2 3 4 5 6 7
TC
Deriving marginal costs
Q TC MC0 12 1 22 2 28 3 33 4 40 5 52 6 72 7 103
10 6 5 7122031
Costs (£)
TC = 12
Q = 1
22 November 05
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0
20
40
60
80
100
120
0 1 2 3 4 5 6 7
TC
MCDiminishingreturns set
in here
Costs (£) Deriving marginal costs
Q TC MC0 12 1 22 2 28 3 33 4 40 5 52 6 72 7 103
10 6 5 7122031
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0
5
10
15
20
25
30
35
0 1 2 3 4 5 6 7
MC
Costs (£) Deriving marginal costs
Diminishing marginalreturns set in here
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Short-run costsShort-run costs
Average cost=TC / Q
Average cost=TC / Q
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0
5
10
15
20
25
30
35
0 1 2 3 4 5 6 7
Costs (£)
26 November 05
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0
5
10
15
20
25
30
35
0 1 2 3 4 5 6 7
Q TVC AVC0 0 -1 10 102 16 83 21 74 28 75 40 86 60 107 91 13
Costs (£)
AFC
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0
5
10
15
20
25
30
35
0 1 2 3 4 5 6 7
Costs (£)
AFC
AVC
Q TVC AVC0 0 -1 10 102 16 83 21 74 28 75 40 86 60 107 91 13
28 November 05
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0
5
10
15
20
25
30
35
0 1 2 3 4 5 6 7
Q TC AC0 12 1 22 222 28 143 33 114 40 105 52 10.46 72 127 103 14.7
Costs (£)
AFC
AVC
29 November 05
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0
5
10
15
20
25
30
35
0 1 2 3 4 5 6 7
Costs (£)
AC
AFC
AVC
Q TC AC0 12 1 22 222 28 143 33 114 40 105 52 10.46 72 127 103 14.7
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0
5
10
15
20
25
30
35
0 1 2 3 4 5 6 7
Q TC MC0 12 1 22 2 28 3 33 4 40 5 52 6 72 7 103
10 6 5 7122031
Costs (£)
31 November 05
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0
5
10
15
20
25
30
35
0 1 2 3 4 5 6 7
MC
Costs (£) Q TC MC0 12 1 22 2 28 3 33 4 40 5 52 6 72 7 103
10 6 5 7122031
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0
5
10
15
20
25
30
35
0 1 2 3 4 5 6 7
MC
Q TC MC AC0 12 1 22 2 28 3 33 4 40 5 52 6 72 7 103
10 6 5 7122031
-2214111010.41214.7
Costs (£)
33 November 05
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0
5
10
15
20
25
30
35
0 1 2 3 4 5 6 7
MC
Costs (£)
AC
Q TC MC AC0 12 1 22 2 28 3 33 4 40 5 52 6 72 7 103
10 6 5 7122031
-2214111010.41214.7
34 November 05
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Output (Q)
Co
sts
(£)
AFC
AVC
MC
x
AC
z
y
Average and marginal costsAverage and marginal costs
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Long-run costsLong-run costs
Long-run costs=TC / Q
Long-run costs=TC / Q
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Long-run costsLong-run costs
Long run
A period of time long enough that a firm can change all the factors of production, meaning that a firm can modify its existing production facility or build a new one
Long-run average cost (LAC)
Long-run total cost divided by the quantity of output produced
Long-run total cost
The total cost of production in the long run when a firm is perfectly flexible in its choice of all inputs and can choose a production facility of any size
37 November 05
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Returns to scaleReturns to scale Economies of scale
A situation in which an increase in the quantity produced decreases the long-run average cost of production
Diseconomies of scale
A situation in which an increase in the quantity produced increases the long-run average cost of production
Constant returns to scale
The total cost of production in the long run when a firm is perfectly flexible in its choice of all inputs and can choose a production facility of any size
Minimum efficient scale
The output at which the long-run average cost curve becomes horizontal
38 November 05
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Alternative long-run average cost curvesAlternative long-run average cost curvesAlternative long-run average cost curvesAlternative long-run average cost curves
OutputO
Co
sts
LRAC
Economies of Scale
39 November 05
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OutputO
Co
sts
Diseconomies of ScaleLRAC
Alternative long-run average cost curvesAlternative long-run average cost curvesAlternative long-run average cost curvesAlternative long-run average cost curves
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OutputO
Co
sts
LRAC
Constant costs
Alternative long-run average cost curvesAlternative long-run average cost curvesAlternative long-run average cost curvesAlternative long-run average cost curves
41 November 05
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A typical long-run average cost curveA typical long-run average cost curveA typical long-run average cost curveA typical long-run average cost curve
OutputO
Co
sts
LRAC
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OutputO
Co
sts
LRACEconomiesof scale
Constantcosts
Diseconomiesof scale
A typical long-run average cost curveA typical long-run average cost curveA typical long-run average cost curveA typical long-run average cost curve
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Long-run average and marginal costs
OutputO
Co
sts
LRAC
LRMC
Economies of Scale
44 November 05
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OutputO
Co
sts
LRAC
LRMC
Diseconomies of Scale
Long-run average and marginal costs
45 November 05
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OutputO
Co
sts
LRAC = LRMC
Constant costs
Long-run average and marginal costs
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OutputO
Co
sts
LRMC
LRAC
Initial economies of scale,then diseconomies of scale
Long-run average and marginal costs
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Long-run costsLong-run costs
Relationship between short-run and long-run
AC curves
Relationship between short-run and long-run
AC curves
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Deriving long-run average cost curves: factories of fixed size
SRAC3
Co
sts
OutputO
SRAC4
SRAC5
5 factories
4 factories3 factories2 factories
1 factory
SRAC1 SRAC2
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SRAC1
SRAC3
SRAC2 SRAC4
SRAC5
LRAC
Co
sts
OutputO
Deriving long-run average cost curves: factories of fixed size
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Co
sts
OutputO
Examples of short-runaverage cost curves
Deriving long-run average cost curves: choice of factory size
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LRAC
Co
sts
OutputO
Deriving long-run average cost curves: choice of factory size
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53 November 05
Perfect competition
Perfect competition and perfectly
competitive firm
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Perfect Perfect CompetitionCompetition
54 November 05
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Perfect competitionPerfect competition
Short-run equilibrium of firm and industry (profit maximising)
Short-run equilibrium of firm and industry (profit maximising)
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O
£
(b) Firm
Q (thousands)
O
(a) Industry
P
Q (millions)
S
D
Pe
MC
ARD = AR
= MR
Qe
AC
AC
Short-run equilibrium of industry and firm under perfect competitionShort-run equilibrium of industry and firm under perfect competition
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Perfect competitionPerfect competition
The industrysupply curveThe industrysupply curve
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O O
(a) Industry
P £
P1
Q (millions)
S
D1
(b) Firm
D1 = MR1
MC
P2
D2 = MR2
D2
P3
D3 = MR3
D3
Q (thousands)
Deriving the short-run supply curve
a
b
c
= S
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Perfect competitionPerfect competition
Long-run equilibriumLong-run equilibrium
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O O
P £
Q (millions)
S1
D
LRAC
PL
P1
QL
Se
AR1 D1
ARL DL
Q (thousands)
Long-run equilibrium under perfect competitionLong-run equilibrium under perfect competition
New firms enterSupernormal profitsProfits return
to normal
(a) Industry (b) Firm60
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£
Q O
(SR)AC
(SR)MC
LRAC
AR = MR
DL
LRAC = (SR)AC = (SR)MC = MR = AR
Long-run equilibrium of the firm under perfect competitionLong-run equilibrium of the firm under perfect competition
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Perfect competition
Profit Maximisation &
Loss Minimisation
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Profit Profit MaximisatioMaximisatio
n n 63 November 05
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Profit maximisationProfit maximisationNormal profit versus
Economic profit
Economic profit (EP) Total revenue minus the total economic cost Normal profit (NP) The portion of firm’s cost that is not included in accounting cost
EP = TR – TC
TR = P x Q
Normal profit versus Economic profit
Economic profit (EP) Total revenue minus the total economic cost Normal profit (NP) The portion of firm’s cost that is not included in accounting cost
EP = TR – TC
TR = P x Q64 November 05
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Profit maximisationProfit maximisation
Using total cost and revenue curves
(a) Price taking firm
Using total cost and revenue curves
(a) Price taking firm
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Total profit = £100 × 46 = £4600
TR
Costs andrevenue (£)
Quantity
600
500
400
300
200
100
00 10 20 30 40 50 60
Price-taking firm
TC
100
46
b
a
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Profit maximisationProfit maximisation
Using total cost and revenue curves
(b) Firm facing downward sloping demand curve
Using total cost and revenue curves
(b) Firm facing downward sloping demand curve
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-8
-4
0
4
8
12
16
20
24
1 2 3 4 5 6 7
TR
, TC
, T
(£
)
Quantity
Finding maximum profit using total curves
68 November 05
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-8
-4
0
4
8
12
16
20
24
1 2 3 4 5 6 7
TR
, TC
, T
(£
)
TR
Quantity
Finding maximum profit using total curves
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-8
-4
0
4
8
12
16
20
24
1 2 3 4 5 6 7
TR
, TC
, T
(£
)
TR
TC
Quantity
Finding maximum profit using total curves
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-8
-4
0
4
8
12
16
20
24
1 2 3 4 5 6 7
TR
, TC
, T
(£
)
T
TR
TC
Quantity
Finding maximum profit using total curves
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-8
-4
0
4
8
12
16
20
24
1 2 3 4 5 6 7
TR
, TC
, T
(£
)
T
TR
TC
a
b
c d
Quantity
Finding maximum profit using total curves
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-8
-4
0
4
8
12
16
20
24
1 2 3 4 5 6 7
TR
, TC
, T
(£
)
T
TR
TC
d
e
f
Quantity
Finding maximum profit using total curves
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Profit maximisationProfit maximisation
Using average and marginal cost and
revenue curves
(a) Price taking firm
Using average and marginal cost and
revenue curves
(a) Price taking firm
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Total profit= £16 x 40 = £640
AR = MR
MC50
40
30
20
10
00 10 20 30 40 50 60
Quantity
Costs andRevenue (£)
22
a
Price-taking firm
AC38
b
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Profit maximisationProfit maximisation
Using average and marginal cost and
revenue curves
(b) Firm facing downward sloping demand curve
Using average and marginal cost and
revenue curves
(b) Firm facing downward sloping demand curve
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-4
0
4
8
12
16
1 2 3 4 5 6 7Quantity
Co
sts
and
rev
enu
e (
£)
Finding the profit-maximising output using marginal curves
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-4
0
4
8
12
16
1 2 3 4 5 6 7Quantity
Co
sts
and
rev
enu
e (
£)
MC
Finding the profit-maximising output using marginal curves
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-4
0
4
8
12
16
1 2 3 4 5 6 7Quantity
Co
sts
and
rev
enu
e (
£)
e
MR
MC
Profit-maximisingoutput
Finding the profit-maximising output using marginal curves
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-4
0
4
8
12
16
1 2 3 4 5 6 7Quantity
Co
sts
and
rev
enu
e (
£)
Measuring the maximum profit using average curves
MR
MC
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-4
0
4
8
12
16
1 2 3 4 5 6 7Quantity
Co
sts
and
rev
enu
e (
£)
MR
MC
AR
Measuring the maximum profit using average curves
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6.00
4.50
-4
0
4
8
12
16
1 2 3 4 5 6 7
MR
Quantity
Co
sts
and
rev
enu
e (
£)
MC
AC
AR
b
a
Total profit =£1.50 x 3 = £4.50
Measuring the maximum profit using average curves
T O T A L P R O F I TT O T A L P R O F I T
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Loss Loss MinimisationMinimisation
83 November 05
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O
Co
sts
and
rev
enu
e (
£)
Quantity
MC
AC
AR
MR
Q
AC
AR
Loss-minimising output
LOSSLOSS
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Profit maximisationProfit maximisation
Short-runshut-down point
Short-runshut-down point
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The short-run shut-down point
O
Co
sts
and
rev
enu
e (
£)
Quantity
AR
AVC
ACP =AVC
Q
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Costs and supply. Perfect Costs and supply. Perfect competitioncompetition
Costs and supply. Perfect Costs and supply. Perfect competitioncompetition
Questions for discussions:1. Most supply curves are vertical ?2. So what is a firm ?3. To maximise profit, maximise sales ?4. Scale economies and the Internet ?5. Small is beautiful - big is again
beautiful ? 6. Firms making losses should quit at
once ?
Questions for discussions:1. Most supply curves are vertical ?2. So what is a firm ?3. To maximise profit, maximise sales ?4. Scale economies and the Internet ?5. Small is beautiful - big is again
beautiful ? 6. Firms making losses should quit at
once ?
87 November 05
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Assignment for week # 6:Essay question: Productivity and
Technological changes ?
Assignment for week # 6:Essay question: Productivity and
Technological changes ?
Introduction to EconomicsIntroduction to EconomicsIntroduction to EconomicsIntroduction to Economics
88 November 05