shut down point and profit
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BellringerOn slates,
1. Identify the firm’s short run variable
costs2. Identify the firm’s short run fixed costs3.If 200 customers
show up, what is their total revenue?
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Exam review speed “dating”
• Desks in 2 rows facing each other, 10 sets
• 45 seconds each question, 17 minutes total
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Have you ever seen this?Why is this firm still open?
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A C T I V E L E A R N I N G A 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, PMC
ATCP = $10 MR
50
$6
A competitive firm
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A C T I V E L E A R N I N G A C T I V E L E A R N I N G 22 AnswersAnswers
5
profit
Q
Costs, PMC
ATCP = $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
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A C T I V E L E A R N I N G A 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, PMC
ATC
A competitive firm
$5
P = $3 MR
30
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A C T I V E L E A R N I N G A C T I V E L E A R N I N G 33 AnswersAnswers
7
lossMRP = $3
Q
Costs, PMC
ATC
A competitive firm
loss per unit = $2
Total loss = (ATC – P) x Q = $2 x 30= $60
$5
30
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With partner• Universal Widgets• Has this cost structure:• Quantity ATC
500 200501 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
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With partner• Universal Widgets• Has this cost structure:• Quantity ATC TC = Q*ATC
500 200 100,000501 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
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FIRMS IN COMPETITIVE MARKETS 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.
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FIRMS IN COMPETITIVE MARKETS 11
P1 MR
P2 MR2
MC and the Firm’s Supply DecisionIf 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 Q2the MC curve is the firm’s supply curve.
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FIRMS IN COMPETITIVE MARKETS 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.
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FIRMS IN COMPETITIVE MARKETS 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
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FIRMS IN COMPETITIVE MARKETS 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).
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15
Sunk Costs• Sunk cost: 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.
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FIRMS IN COMPETITIVE MARKETS 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
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FIRMS IN COMPETITIVE MARKETS 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
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FIRMS IN COMPETITIVE MARKETS 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
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Side by side graphsLR economic profits = 0