Micro Handout 12: Supply in the Long Run

Transcription

1 Amherst College epartment of Economics Economics 111 ection 5 Fall 2015 Micro Handout 12: upply in the Long Run Review: hort Run and Long Run hort Run Firms must meet their short run fixed commitments Terminology: When a firm goes out business in the short run, we say that the firm shuts down. hort Run hutdown Rule rice () and Average Variable Cost (AVC) < AVC Firm goes out of business in the short run. Firm shuts down. Long Run Firms can escape their short run fixed commitments Terminology: When a firm goes out business, we say That the firm exits the industry. Long Run Exit Rule rice () and Average Total Cost () < Firm goes out of business. Firm exits the industry. Review: Jeff Lord s Consulting Firm On January 1, 2015, Jeff Lord resigned from Arthur Anderson where he worked as a business consultant earning $25,000 a month, to start his own consulting firm. He signed a one-year lease for office space. The one-year lease legally reuires Jeff to pay his landlord $20,000 per month in rent until January 1, He hired several employees whose wages summed to $35,000 a month Total Costs (TC) $80,000 Jeff departed from Anderson on very good terms; the management at Anderson told him that he could return to their firm anytime at his old $25,000 per month salary. Accounting Costs $55,000 Opportunity Costs $25,000 Rent Employee Wages Anderson alary $20,000 $35,000 $25,000 uestion: What date separates the short run from the long run? uestion: On January 1, 2016 will Jeff continue to operate his firm or will he go out of business and return to Anderson? uestion: To decide this uestion what we will compare?

2 2 The Long Run: After January 1, 2016 He signed a one-year lease for office space. The one-year lease legally reuires Jeff to pay his landlord $20,000 per month in rent until January 1, He hired several employees whose wages summed to $35,000 a month Total Costs (TC) $80,000 Jeff departed from Anderson on very good terms; the management at Anderson told him that he could return to their firm anytime at his old $25,000 per month salary. Accounting Costs $55,000 Opportunity Costs $25,000 Rent Employee Wages Anderson alary $20,000 $35,000 $25,000 uestion: Will Jeff operate his firm (after January 1, 2016) or will he not renew his lease, vacate his office, go out of business and return to his job at Anderson. To address this uestion compare the income Jeff would earn in each case: Jeff s monthly income Jeff s monthly income if if he continues to = $ $ = $ he goes out of business = $ operate his firm on January 1, 2016 = Total Revenue Costs = Costs After January 1, 2016, Jeff would. The Long Run and rofit Claim: ince (the economist s) total cost includes opportunity costs, profit compares the income Jeff would earn if he operates his firm if the income if he would earn if he goes out of business. rofit = Total Revenue Total Costs Total Costs = Accounting Costs + Opportunity Costs = Total Revenues (Accounting Costs + Opportunity Costs) = Total Revenues Accounting Costs Opportunity Costs = (Total Revenues Accounting Costs) Opportunity Costs = Jeff s monthly income Jeff s monthly income

3 3 Claim: Long run behavior depends on price () and average total cost ()? rofits = Total Revenues Total Costs = TR TC TR = = Factoring out : = ( ) = TC = TC We have three cases: < = > rofit < 0 rofit = 0 rofit > 0 Jeff s income Jeff s income in Jeff s income Jeff s income in Jeff s income Jeff s income in if he the long run if he the long run if he the long run operates if he goes operates if he goes operates if he goes his firm out of business his firm out of business his firm out of business Jeff earns income by Jeff earns income Jeff is earns income by operating his firm than by operating his firm or by operating his firm than by working for someone else. by working for someone else. by working for someone else. Jeff the industry Entrepreneurs the industry Relationship between a Firm s Marginal Cost Average Total Cost Curves Claim: The upward sloping marginal cost curve and the U-shaped average total cost curve intersect at the point of minimum average total cost: When marginal cost is less than average cost, average total cost is. When marginal cost exceeds average cost, average total cost is., Justification: uppose that the average weight of us in the classroom euals 150 pounds. Then, one more person walks into the room. How will the additional person affect our average weight? Consider two scenarios: Additional person weighs 30 pounds Additional person weighs 330 pounds Weight of additional person is Weight of additional person is than the average. than the average. The average. The average. We can view the weight of the additional person as the marginal weight:

4 4 Marginal Weight = Change in the total weight of us in the classroom resulting from a one person change in the classroom size. Marginal below average Marginal above average Average Average NB: This has nothing to do with economics; it is a much more fundamental principle. If the average total cost curve and marginal cost curve did not intersect at minimum average total cost, this fundamental principle would be violated: Intersection to the right of min Intersection to the left of min,,, < rising cannot occur > falling cannot occur utting the ieces Together: The Euilibrium and the In a competitive industry, the euilibrium price and uantity is determined by MR, the market demand curve and the market supply curve. * emand Curve upply Curve uestion: Where does the market supply curve come from? Individual Firm s upply Curve uestion: Where does the individual firm s supply curve come from? Euilibrium rice erfectly Competitive Industry Average Total Cost () Curve Three cenarios:

5 5 Three cenarios: Euilibrium rice, Minimum Average Total Cost, and the Long Run Euilibrium price less than minimum average total cost: < min Max profit: = * Firm s rofit 0 Firms will upply curve rice will MR, Euilibrium price greater than minimum average total cost: > min Max profit: = * Firm s rofit 0 Firms will upply curve rice will MR, Euilibrium price eual to minimum average total cost: = min Max profit: = * Firm s rofit 0 Is this a long run euilibrium? Explain. MR,

6 6