1~~11!~1. lrc"rc~ IAr~I. The Generic Cost Curve-The Short-Run (SR)

Transcription

1 The Generic Cost Curve-The Short-Run (SR) Although the graphed curves on the right use exactly the same information as the table on the left, they are more useful. The curves are called the marginal cost curve (MC), the average total cost curve (ATC), and the average variable cost curve (AVC). Quantity (pianos moved Total Fixed Variable Average Average Average Marginal DOLIJ\l!S per day) Costs Costs Costs Total Cost Fixed Cost Variab le Cost (Q) (TC) (FC) (VC) (ATC) (AFC) Cost (AVC) (MC) ' Marginal cost (MC) Averag e lotal cosl 6 1, (ATC) 7 1) , , AYerage 9 1, , variable 10 1, , cost (AVG) A , Page 1 lrc"rc~ IAr~I 1~~11!~1 Chan9e Change in Q in TC G 7 8 n Qt1ANT l1'y

2 The Generic Cost Curve-The Short-Run (cont.) The relationship between marginal and average allows us to sketch a generic cost curve diagram which characterizes virtually all firms. Again, we are now focusing on individual firms in a competitive market, not markets themselves. Note that the marginal cost curve (MC) cuts both the average variable cost (AVC) curve and the average total cost curve (ATC) at their minimum points. Also note the flat demand (D) curve added in whose intersection with the MC curve establishes the equilibrium price (Pe) and equilibrium quantity (Qe). Price Page 2 AFirm Equilibrium price (Pe), -...,.....,.~ demand (D), marginal benefit (MB), I I I and marginal I I revenue (MR) I Profit maximizing quantit~:.1v c (S) Equilibrium quantity (Qe) Quantity

3 Microeconomics Do-Now Please do this: 1. Draw a generic cost curve for firms and include the demand curve and the profit maximizing point. Page 3

4 The Generic Cost Curve-The Short-Run (cont.) Notice that the distance between the average total cost (ATC) curve and the average variable cost (AVC) curve gets smaller as production increases because fixed costs (FC) are a smaller proportion of total costs (TC) as production increases. D<H... LAH. 1l/ C A1C A t 1 V Page 4

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6 The Profit or 1,oss Rectangle Profits equal total revenue (TR) minus total costs (TC). To calculate profits by using a graph, we need to represent the total revenue and total costs on the graph. Because the width of this rectangle is the quantity produced (Q) and the height of this rectangle is the market price (P), the area is P x Q, or total revenue. Below, the total revenue is $60, but then you must calculate the total costs (the area from ATC down, $40) to determine profit, which is $20 (TR$60- TC$40== $20). Price A Firm Pe, D, MB, Profit and MR 7 MCandS Total revenu (TR) Page 6 revenue Total( s profit Total 3 cost 2 (TC) 1 = $60 (10 X $6) iiiiilllll~ -----~...,..._ ~ ~ Profit maximizing quanti~ ATC AVC Equilibrium quantity (Qe) Quantity

7 The Profit or 1,oss Rectangle (cont.) Observe the point where the average total cost (ATC) curve intersects the dashed vertical line, the quantity supplied (Qs). This point tells us what the firm's average total cost is when it produces the profit-maximizing quantity. The area of the rectangle with the hash marks shows the firm's total costs. If the firm chose to increase its price (P) in order to increase its revenue, its revenue would fall massively or fall to "O" because the firm's customers will go elsewhere because the firm has no market power; it is a price-taker and its price perfectly elastic. Price A Firm Page 7 Pe, D, MB, Profit MCandS and MR Total revenu (TR) Total 3 cost 2 (TC) 1 revenue ~ $60 (10 X $6) 1 2 total pro it= O $60-$40) l costs== X ~ -~:::::----- ' ATC AVC : Equilibrium Profit maximizing quantity'.: quantity (Qe) ~ Quantity

8 Profits or 1,osses? Since profits are total revenue (TR) less total costs (TC), we compute profits by looking at the difference between the two rectangles, in this case, both combined (revenue) minus the one on the bottom, total costs. The difference is itself a rectangle, shown by the part of the rectangle that rises above the total costs rectangle. Profits are positive because total revenue is greater than total costs. Price Pe, D, MB, and MR Total revenu (TR) revenue = $60 (10 X $6) Total 3 cost 2 (TC) 1 AFirm Profit total pro it= O $60-$40) MCandS : Equilibrium Profit maximizing quantify,.)~ quantity (Qe) Quantity ~ ~ v _ -- Page 8

9 Profits or 1,osses? (cont.) Now comes the rough part, losses. The market price (P) is at the intersection of the marginal cost curve (MC) and the market price line. The intersection of MC and the market price line also gives you the loss-minimizing price and quantity because supply (S) and demand (D) are at equilibrium. At this quantity of production (Q), the per-unit price or average total cost (ATC) is above the price, and there will be a loss in profit because the total costs (TC) are more than the total revenue (TR). Page 9 Total revenue (TR) total revenue= $28 (7 X $4) Price Total costs 4 (TC) A Firm Losses Market equilibrium (Me) ~---~-~...iiiiii.~... --""'... 1 ' ~ MC and s ATC AVC ~~...,.. ~~ ~ ~~~ --.,Pe, D, MB, andmr total revenue- - I $28 (7 X $4) ; Equilibrium quantity (Qe) Quantity

10 Profits or 1,osses? (cont.) The intersection of MC and the market price line indicates the allocatively efficient price and quantity that is best for society. Between that intersection and the intersection of the average total cost curve (ATC) and the profit-maximizing quantity produced is the area of loss. Pricel 7 Total 6 reve nue 5 (TR) otal costs 4 tota l (TC) 3 reven ue = $28 (7 X $4) 2 1 AFirm Losses Ma rket equilibrium (Me) MCandS ~ ~ ;;..;..: sz:;...;;;.~ ~:;.._~ ;...;;~...al!!...-=:~ --., Pe, D, MB, 3 4 ' E 1 b. and MR total revenue - : q Ul I r1um $28 (7 x $4) :.---::::quantity (Qe) Qu antity Page 10

11 Microeconomics Do-Now Please do this: 1. Draw two graphs, one showing short-run profits in a firm and one showing short-run losses in a firm. 2. On either graph, show a shift in the supply curve above the ATC. State the impact of the shift on the profit or losses of the graph you used. Page 11

12 The Breakeven Point Now draw the market price (P) line through the point where the marginal cost curve (MC) intersects the average total cost curve (ATC). This is the breakeven point, minimum point on the average total cost curve. At that price, the firm chooses a quantity for which average total cost equals the price. The total revenue rectangle and the total cost ( TC) rectangle are exactly the same. There are zero economic profits. Equilibrium Price A Eirm price (Pe), demand (D), marginal benefit (MB), and marginal revenue (MR) Breakeven point MCandS ATC AVC Total Total revenue = costs (TR) (TC) ~~~~~. Equililirium j/quantity (Qe) Profits = 0 / Breakeven = (P = ATC) Q Quantity Page 12

13 The Breakeven Point (cont.) Thus, the difference between their areas is zero. At that price (P), the firm is at a breakeven point: P == ATC, and economic profits are zero. Notice that as demand (D) increases (P to Pl), it shifts up along the supply(s)/marginal cost (MC) curve. Equilibrium Price A Firm price (Pe), demand (D), marginal benetit (MB), and marginal revenue (MR) otal Total revenue = costs (TR) (TC) Breakeven point MCandS ATC AVC ~ ~~ --r. Equilibrium, I/q uantity (Qe) Q Q. uant1ty Profits = 0 / Breakeven = (P = ATC) Page 13

14 The Breakeven Point (cont.) The firm earns positive profits if the price is greater than the breakeven point (P > ATC), as shown below. Price Pe, D, 1\lB, and MR 7 AFirm Profit MCandS Total revenu (TR) Page 14

15 The Breakeven Point (cont.) The firm has negative profits ( a loss) if the price is lower than the breakeven point (P < ATC), as shown below. The case of negative profits raises the question of why a firm does not shut down. By continuing operations, the firm can minimize its losses. Total revenue (TR) total revenue = $28 (7 X $4) Price I costs (TC) AFirm Losses Market equilibrium (Me) MCandS ~ ~ :;...;..:~...:;.~ ~~~ ~ -=-~...-::::;... --,. Pe, D, MB, : and MR 3 4 total revenue- : Equilibrium $28 (7 x $4) :.-----quantity (Qe) Qu antity Page 15

16 The Breakeven Point-Questions 10. A ss urne that a pr ofit -maximi zing, perf ec tly comp etiti ve firm has eco nomi c losses in the short run. If th e firm continu es to pr odu ce and se ll its goo d, th en whi ch of the follow in g mu st be tru e? (A ) Th e firm is cove rin g a ll of its fix ed and variabl e cos ts of pr odu ction. (B ) Th e firm is cove rin g all of its fix ed cos ts but not all of its variab le cos ts of pr odu ction. (C) Th e firm is cove rin g all of its va riable cos ts but not a ll of its fi xed co ts of produ ction. (D ) Th e firm is cove ring a ll of its itnpli cit co t but not all of its exp licit cos ts. (E ) Th e firm mu st have raised the pri ce of its goo ds in order to minimi ze its losses. 9. Supp ose that price in a perfec tly co mp etitive indu stry dec rea es and it is now below minimum ave rage total cos t but remain s abo ve m inimum ave rage var iable cost. Whi ch of the followin g will occ ur in the hort run? Page 16 (A ) N ew firm s will ent er the indu stry. (B ) Firm s will increase output so that mar ginal reve nue eq uals the new price. (C) Firm s will pro duce the output at w hich ave rage total cos t i at a minitnum. (D ) Firm s will produ ce the output at which marg inal co st equal s the new pr ice. (E) Firm s will not pr odu ce at all. ince they will be unable to cover all their c o ts.

17 The Breakeven Point-Questions 10. A ss urne that a pr ofit -maximi zing, perf ec tly comp etiti ve firm has eco nomi c losses in the short run. If th e firm continu es to pr odu ce and se ll its goo d, th en whi ch of the follow in g mu st be tru e? (A ) Th e firm is cove rin g a ll of its fix ed and variabl e cos ts of pr odu ction. (B ) Th e firm is cove rin g all of its fix ed cos ts but not all of its variab le cos ts of pr odu ction. Th e firm is cove rin g all of its va riable cos ts but not a ll of its fi xed co ts of produ ction. (D ) Th e firm is cove ring a ll of its itnpli cit co t but not all of its exp licit cos ts. (E ) Th e firm mu st have raised the pri ce of its goo ds in order to minimi ze its losses. 9. Supp ose that price in a perfec tly co mp etitive indu stry dec rea es and it is now below minimum ave rage total cos t but remain s abo ve m inimum ave rage var iable cost. Whi ch of the followin g will occ ur in the hort run? Page 17 (A ) N ew firm s will ent er the indu stry. (B ) Firm s will increase output so that mar ginal reve nue eq uals the new price. (C) Firm s will pro duce the output at w hich ave rage total cos t i at a minitnum. - Firm s will produ ce the output at which marg inal co st equal s the new pr ice. (E) Firm s will not pr odu ce at all. ince they will be unable to cover all their c o ts.

18 The Shutdown Point The firm should shut down if the price (P) falls below the minimum point of the average variable cost curve (AVC) and is not expected to rise again, which is ref erred to as the shutdown point. When total revenue is less than the average variable costs (AVC), it makes sense to stop producing, as shown below. Price Equilibrium price (Pe), demand (D), marginal benefit (MB), and marginal revenue (MR)...,. AFirm Shutdown point p ~ ----= = ~=====!, ~ =:::::::: :... '( Q MCandS ATC AVC Quantity Profits are negative and P is less than AVC shutdown= (P < AVC) Page 18

19 The Shutdown Point (cont.) The graph below shows the case where the price is below the average variable cost (P < AVC) and the firm should shut down. However, if the price is above average variable cost (P > AVC), the firm should not shut down, even if the price is below average total cost and profits are negative. As long as the price (P) is above the average variable cost (AVC), the firm will produce a quantity such that marginal cost (MC) equals the price. Page 19 Price I Equilibrium price (Pe), demand (D), marginal benefit (MB), and marginal revenue (MR) --.. p AFirm Shutdown point ~ ---= ~==~,~E::::::=--- '( -Q MCa nds ATC AVC Quantity Profits are negative and P is less than AVC shutdown= (P<AVC)

20 The Shutdown Point-Questions 24. For a perfectly co1npetitive firm producing the profit-rnaxitnizing quantity the average total co t i $10 and th averag variable cost i $8. If th n1arket price for it product i $10 which of the following is true for the firm? (A) It i u taining a lo and should shut down. (B) It i earning zero economic profit and will re1nain in bu ine. (C) Its accounting profits exceed itnplicit costs. (D) It will te1nporarily shut down until price rise. (E) It i rnaking an economic profit that will attract other firms to the indu try. 52. A profit-1naximizing finn will hut down in the hort run any time th firm" than it (A) total co t (B) fix d cost (C) total variabl co t (D) exolicit co t total r venue i I Page 20

21 The Shutdown Point-Questions 24. For a perfectly co1npetitive firm producing the profit-rnaxitnizing quantity the average total co t i $10 and th averag variable cost i $8. If th n1arket price for it product i $10 which of the following is true for the firm? (A) It i u taining a lo and should shut down. (e ) It i earning zero economic profit and will re1nain in bu ine. (C) Its accounting profits exceed itnplicit costs. (D) It will te1nporarily shut down until price rise. (E) It i rnaking an economic profit that will attract other firms to the indu try. 52. A profit-1naximizing finn will hut down in the hort run any time th firm" than it (A) total co t (B) fix d cost. ) total variabl co t (D) exolicit co t total r venue i I Page 21

22 The Shutdown Point-Questions 52. In the hort run if a firrn produce the I vel of output at which rnarginal revenue i equal to marginal co t but price i l than av rage total co t th firm will (A alway hut down production (B xpand output to lower it average fixed co t (C continu t operate if pric i great r than it averag variabl co t (D deer a output until pric equal it average total co t (E increa e output to increa revenue Page 22

23 The Shutdown Point-Questions 52. In the hort run if a firrn produce the I vel of output at which rnarginal revenue i equal to marginal co t but price i l than av rage total co t th firm will (A alway hut down production < (B xpand output to lower it average fixed co t continu t operate if pric i great r than it averag variabl co t (D deer a output until pric equal it average total co t (E increa e output to increa revenue Page 23

24 The Shutdown Point (cont.) Economists have developed the concept of sunk cost, which may help you understand and remember why a firm would continue to operate in the short run even though it was reporting losses. A sunk cost is a cost that you have committed to pay and that you cannot recover. Rental payments are an example of a sunk cost. The important thing about a sunk cost is that once you commit to it, there is nothing you can do about it, so you might as well ignore it in your decisions. Page 24

25 Microeconomics Do-Now Please do this: 1. Draw a graph showing a firm at the breakeven point and another graph showing the shutdown point. Page 25