Economics
Shutdown Point in Perfect Competition
The shutdown point in perfect competition is the level of output at which a firm covers its variable costs but not its fixed costs. At this point, the firm is indifferent between producing and shutting down, as it cannot cover its total costs. If the price falls below the shutdown point, the firm will minimize losses by ceasing production.
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10 Key excerpts on "Shutdown Point in Perfect Competition"
eBook - PDF- Steven A. Greenlaw, Timothy Taylor, David Shapiro(Authors)
- 2017(Publication Date)
- Openstax(Publisher)
We call the point where the marginal cost curve crosses the average cost curve, at the minimum of the average cost curve, the “zero profit point.” If the market price that a perfectly competitive firm faces is below average variable cost at the profit-maximizing quantity of output, then the firm should shut down operations immediately. If the market price that a perfectly competitive firm faces is above average variable cost, but below average cost, then the firm should continue producing in the short run, but exit in the long run. We call the point where the marginal cost curve crosses the average variable cost curve the shutdown point. Chapter 8 | Perfect Competition 207 8.3 Entry and Exit Decisions in the Long Run In the long run, firms will respond to profits through a process of entry, where existing firms expand output and new firms enter the market. Conversely, firms will react to losses in the long run through a process of exit, in which existing firms cease production altogether. Through the process of entry in response to profits and exit in response to losses, the price level in a perfectly competitive market will move toward the zero-profit point, where the marginal cost curve crosses the AC curve at the minimum of the average cost curve. The long-run supply curve shows the long-run output supplied by firms in three different types of industries: constant cost, increasing cost, and decreasing cost. 8.4 Efficiency in Perfectly Competitive Markets Long-run equilibrium in perfectly competitive markets meets two important conditions: allocative efficiency and productive efficiency. These two conditions have important implications. First, resources are allocated to their best alternative use. Second, they provide the maximum satisfaction attainable by society. SELF-CHECK QUESTIONS 1. Firms in a perfectly competitive market are said to be “price takers”—that is, once the market determines an equilibrium price for the product, firms must accept this price.
eBook - PDF- Steven A. Greenlaw, Timothy Taylor(Authors)
- 2015(Publication Date)
- Openstax(Publisher)
The point where the marginal cost curve crosses the average cost curve, at the minimum of the average cost curve, is called the “zero profit point.” If the market price faced by a perfectly competitive firm is below average variable cost at the profit-maximizing quantity of output, then the firm should shut down operations immediately. If the market price faced by a perfectly competitive firm is above average variable cost, but below average cost, then the firm should continue producing in the short run, but exit in the long run. The point where the marginal cost curve crosses the average variable cost curve is called the shutdown point. 8.3 Entry and Exit Decisions in the Long Run In the long run, firms will respond to profits through a process of entry, where existing firms expand output and new firms enter the market. Conversely, firms will react to losses in the long run through a process of exit, in which existing firms reduce output or cease production altogether. Through the process of entry in response to profits and 198 Chapter 8 | Perfect Competition This OpenStax book is available for free at http://cnx.org/content/col11858/1.4 exit in response to losses, the price level in a perfectly competitive market will move toward the zero-profit point, where the marginal cost curve crosses the AC curve, at the minimum of the average cost curve. The long-run supply curve shows the long-run output supplied by firms in three different types of industries: constant cost, increasing cost, and decreasing cost. 8.4 Efficiency in Perfectly Competitive Markets Long-run equilibrium in perfectly competitive markets meets two important conditions: allocative efficiency and productive efficiency. These two conditions have important implications. First, resources are allocated to their best alternative use. Second, they provide the maximum satisfaction attainable by society.
eBook - PDF- Steven A. Greenlaw, David Shapiro, Daniel MacDonald(Authors)
- 2022(Publication Date)
- Openstax(Publisher)
We call the point where the marginal cost curve crosses the average cost curve, at the minimum of the average cost curve, the “zero profit point.” If the market price that a perfectly competitive firm faces is below average variable cost at the profit-maximizing quantity of output, then the firm should shut down operations immediately. If the market price that a perfectly competitive firm faces is above average variable cost, but below average cost, then the firm should continue producing in the short run, but exit in the long run. We call the point where the marginal cost curve crosses the average variable cost curve the shutdown point. 8.3 Entry and Exit Decisions in the Long Run In the long run, firms will respond to profits through a process of entry, where existing firms expand output and new firms enter the market. Conversely, firms will react to losses in the long run through a process of exit, in which existing firms cease production altogether. Through the process of entry in response to profits and exit in response to losses, the price level in a perfectly competitive market will move toward the zero-profit 8 • Key Terms 209 point, where the marginal cost curve crosses the AC curve at the minimum of the average cost curve. The long-run supply curve shows the long-run output supplied by firms in three different types of industries: constant cost, increasing cost, and decreasing cost. 8.4 Efficiency in Perfectly Competitive Markets Long-run equilibrium in perfectly competitive markets meets two important conditions: allocative efficiency and productive efficiency. These two conditions have important implications. First, resources are allocated to their best alternative use. Second, they provide the maximum satisfaction attainable by society. Self-Check Questions 1. Firms in a perfectly competitive market are said to be “price takers”—that is, once the market determines an equilibrium price for the product, firms must accept this price.
eBook - PDF- Martha L. Olney(Author)
- 2015(Publication Date)
- Wiley(Publisher)
If the revenue received from operating tomorrow exceeds the variable costs of operating tomorrow, the owner should get up and go to work. The firm should produce. Have a “Going Out of Business” sale. The additional revenue will cover all the variable costs and some of the fixed costs. But if the revenue from operating tomorrow is less than the variable costs of operating tomorrow, shut down. Put a sign on the door: “Sorry, we are now closed.” The losses will be smaller if the firm simply shuts down immediately. What is intuitive can be expressed in a graph. In Figure 6.6, the marginal revenue and marginal cost curves determine the profit-maximizing quantity. The average total cost curve and the price determine the economic loss. The short-run decision of shut down or produce comes from a comparison of the average variable cost curve and the price. If the price falls below the average variable cost, the firm should immediately shut down to minimize losses. Economists call the minimum of the average variable cost curve the shut-down point. In the Long Run, Economic Profit Equals Zero 89 (a) (b) Quantity of output Quantity of output MC $ $ MC MR MR Shut-down point LOSS Shut-down point Shut- down price Shut- down price ATC ATC AVC AVC p 1 q 1 p 1 Figure 6.6 Shut-down point. A firm that is incurring a loss will exit the industry in the long run. In the short run, whether the firm continues to produce or immediately shuts down depends on a comparison of the price and the average variable cost. In Figure 6.6a the firm will continue to produce in the short run because the price of its output is greater than the average variable cost of producing q 1 units of output. The firm’s losses are smaller in the short run by producing. In Figure 6.6b, the firm will shut down immediately because the price of its output is less than the minimum average variable cost. The firm’s losses are smaller in the short run if it does not produce and simply pays its fixed costs.
eBook - PDF- Rhona C. Free(Author)
- 2010(Publication Date)
- SAGE Publications, Inc(Publisher)
If a firm is large enough relative to the market that its output decisions affect the price, there is no price for the firm to take, and consequently there is no supply curve. Of course, if the price is below the firm's shutdown price and its profit-maximizing output cannot cover vari-able cost, it will not produce or supply any input. Remember that at the shutdown point, TR(q) = VC(q), P = A VC(q), and Tr (q) = -ττ(Ο) = -FC. For a price taker, Ρ = MR(q), and it is at its shutdown point where Ρ = MR(q) = MC{q) = AVC{q) (43) which occurs at the minimum point on the A VC(q) curve where MC(q) = min AVC(q). The price-taking firm will shut down and produce q = 0 if Ρ < min A VC(q). For any Ρ > min AVC(q), the firm will produce and supply the quantity (q s ), where Ρ = MC(q s ) > AVC{q). This gener-ates the firm's supply curve q s (P) in Figure 11.5. In Figure 11.6, the perfectly competitive firm's q s (P) is the portion of MC(q) above the minimum point on AVC(q)> where MC{q) = min^KC(c7). If MC(q) and AVC(q) are 118 · MICROECONOMICS Figure 11 .5 Shutdown Point and the Competitive Firm's Supply Curve Figure 11 .6 Marginal Cost, Average Variable Cost, and Competitive Firm's Supply Curve linear, as in Figure 11.6, MC(q) > A VC{q) for all q > 0, and the entire MC(q) curve is the firm's short-run supply curve. Choice of Inputs by the Perfectly Competitive Firm In an economy in which all markets are perfectly com-petitive, the individual firms are price takers in product and factor markets—that is, the prices of the firm's output and of the factor inputs are constants. If labor is a variable factor input, the firm maximizes profit, ir(n), where MFC(n) = MRP(n) and AMFC(n)/An > AMRP(n)/An, which satisfies the necessary and sufficient conditions for maximum ττ(η). As a price taker in the labor market facing a constant wage (w), the marginal factor cost of labor is simply the wage. If w is constant, then Aw/An = 0 a n a MFC(n) = w + η ^ = w.
eBook - PDFMicroeconomics
A Contemporary Introduction
- William A. McEachern(Author)
- 2016(Publication Date)
- Cengage Learning EMEA(Publisher)
Recall that the short-run market supply curve is the sum of each firm’s marginal cost curve at and above its minimum average variable cost. allocative efficiency Each firm produces the output most preferred by consumers; marginal benefit equals marginal cost Copyright 2017 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part. Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s). Editorial review has deemed that any suppressed content does not materially affect the overall learning experience. Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it. Chapter 8 Perfect Competition 187 Point m in Exhibit 13 is the minimum point on the market supply curve; it indicates that at a price of $5, quantity supplied is 100,000 units. At prices below $5, quantity supplied would be zero because firms could not cover average variable cost. A price of $5 just covers average variable cost. If the market price rises to $6, quantity supplied increases until marginal cost equals $6. Market output increases from 100,000 to 120,000 units. Total revenue in this market increases from $500,000 to $720,000. Part of the higher revenue covers the higher marginal cost of production. But the rest provides a bonus to producers. After all, suppliers would have offered the first 100,000 units for only $5 each. If the price is $6, firms get to supply these 100,000 units for $6 each. Producer surplus at a price of $6 is the gold-shaded area between the prices of $5 and $6. In the short run, producer surplus equals the total revenue producers are paid minus their variable cost of production. In Exhibit 13, the market-clearing price is $10 per unit, and producer surplus is depicted by the gold-shaded area between a price of $5 and the market price of $10.
eBook - PDFEconomics
A Contemporary Introduction
- William A. McEachern(Author)
- 2016(Publication Date)
- Cengage Learning EMEA(Publisher)
Copyright 2017 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part. Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s). Editorial review has deemed that any suppressed content does not materially affect the overall learning experience. Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it. Chapter 8 Perfect Competition 179 To Review: A perfectly competitive firm supplies the short-run quantity that maxi- mizes profit or minimizes loss. When confronting a loss, a firm either produces an output that minimizes that loss or shuts down temporarily. Given the conditions for perfect competition, the market converges toward the equilibrium price and quantity. But how is that equilibrium actually reached? In the real world, markets operate based on customs and conventions, which vary across markets. For example, the rules accept- able on the New York Stock Exchange are not the same as those followed in the market for fresh fish. C H E C K P O I N T Describe a perfectly competitive firm’s short-run supply curve. 8-5 Perfect Competition in the Long Run In the short run, the quantity of variable resources can change, but other resources, which mostly determine firm size, are fixed. In the long run, however, a firm has time to enter and leave and to adjust its size—that is, to adjust its scale of operations. In the long run, there is no distinction between fixed and variable cost because all resources under the firm’s control are variable. Short-run economic profit encourages new firms to enter the market in the long run and may prompt existing firms to get bigger. Economic profit attracts resources from industries where firms are losing money or earning only a normal profit. This expan- sion in the number and size of firms shifts the industry supply curve rightward in the long run, driving down the price.
eBook - PDFMicroeconomics
Theory and Applications
- Edgar K. Browning, Mark A. Zupan(Authors)
- 2019(Publication Date)
- Wiley(Publisher)
In the short run, a competitive firm will produce at a point where its marginal cost equals marginal revenue (= P), as long as the price is above the minimum point of the average variable cost curve. In other words, each firm’s marginal cost curve indicates how much the firm will produce at alternative prices. As a first approximation, the short-run industry supply curve is derived by simply adding the quantities produced by each firm—that is, by summing the individual firms’ marginal cost curves horizontally. We assume for now that variable input prices remain constant at all levels of industry output. Figure 9.7 illustrates how a short-run industry supply curve is derived for the three firms (A, B, and C) composing the cement industry. Although three firms may not be enough to constitute a competitive industry, the derivation is the same regardless of the number of firms involved. The figure shows the portion of each firm’s marginal cost (MC) curve lying above its minimum average variable cost (AVC). Because the supply curve identifies the total quantity offered for sale at each price, we will add the outputs each firm chooses to produce individually. At any price below P 0 , the minimum point on firm C’s AVC curve, industry output is zero because all three firms shut down. At P 0 , firm C begins to produce. Note that its output is the only output on the market until price reaches P 1 , because the other companies will not operate at such low prices. Thus, the lower portion of firm C’s MC curve reflects the total industry supply curve at low prices. When price reaches P 1 , however, firm A begins to pro- duce, and its output must be added to C’s—hence, the kink in the industry supply curve at P 1 . When price reaches P 2 , firm B begins production, and its output is included in the supply curve at prices above P 2 .
eBook - PDF- Christian Brockmann(Author)
- 2023(Publication Date)
- Wiley-Blackwell(Publisher)
4 Producers in Perfectly Competitive Markets 94 Output/period y Costs y* Long run supply curve Short run supply curve Figure 4.25 Long- and short-run supply curve by a firm. is based in case 2 as well as in case 3 on MC = p. To avoid a loss, the producer must supply quantities to the right of the minimum of average variable costs (AVC). The thoughts allow formulating the shutdown condition: AVC y c y y v p (4.33) 4.4.2 Long-Run Supply Curve of a Firm If we denote a fixed factor of production by k (e.g. the factory size) then we can formulate for profit maximization in the short run by using MC for marginal costs: p MC y ( , k) (4.34) In the long run, k depends on output, and we get: p MC y y , k (4.35) The quantity y* for which k is optimal in the short run coincides with the long run; this point (p*, y*) is common to both curves. Since the producer can adjust fixed costs in the long run, the corresponding cost curve will be more elastic, i.e. less reactive to price changes (Figure 4.25). In the case of constant average costs, the long‐run supply curve will be horizontal (Figure 4.26). 4.4.3 Market Supply Curve The short‐run market supply curve is the horizontal sum of all individual supply curves: We must add the quantities of all producers who are willing to supply a quantity for a given price (Figure 4.27). eferences 95 References Acemoglu, D. and Robinson, J. (2012). Why Nations Fail: The Origins of Power, Prosperity, and Poverty. New York: Crown Business. Brockmann, C. (2021). Advanced Construction Project Management: The Complexity of Megaprojects. Hoboken: Wiley Blackwell. Cobb, C. and Douglas, P. (1928). A theory of production. American Economic Review 18 (1 Supplement): 139–165. Fandel, G. (1991). Theory of Production and Cost. Berlin: Springer. Jehle, G. and Reny, P. (2011). Advanced Microeconomic Theory. Harlow: Pearson. Leontief, W. (1966). Input‐output analysis. In: Input‐Output Economics (ed. W. Leontief), 134–155.
eBook - PDFIntermediate Microeconomics
An Intuitive Approach with Calculus
- Thomas Nechyba(Author)
- 2018(Publication Date)
- Cengage Learning EMEA(Publisher)
330 CHAPTER 13 PRODUCTION DECISIONS IN THE SHORT AND LONG RUN To see how a firm can stay open in the short run but exit in the long run, consider Graph 13.4, which largely replicates the short-run cost and expenditure curves we derived in panel (b) of Graph 13.1 and that are contained in Graph 13.3. Graph 13.3 Shut-Down Versus Exit Price 0 200 10 €s p Output A MC k = 100 AE k = 100 AC k = 100 AC LR Go to MindTap to interact with this graph Graph 13.4 Output Supply in the Short Run 0 €s Output A' A FE k = 100 FE k = 100 AC = p * p * x * x * Short-run supply curve Short-run supply curve AE k = 100 MC k = 100 AC k = 100 Go to MindTap to interact with this graph Suppose that the price of the output is p* . If this firm produces at all, it will produce x* where the additional cost of producing one more unit of output is just equal to the additional revenue from selling that unit. This would generate total revenue of p*x* , the shaded dark brown rectangle in the graph. At the output level x* , the firm would incur average costs exactly equal to p* , giving total short-run costs equal to the same dark brown rectangle. Thus, the firm is making enough revenues to cover its short-run economic costs. It does not, however, make enough to cover its fixed expenditure FE k 5 100 , represented by the dark blue area, for the fixed amount of capital it has to rent in the short run. Because the firm has to pay FE k 5 100 regardless of whether or not it produces, it does not have to recover FE k 5 100 in the short run Copyright 2018 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part. Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s). Editorial review has deemed that any suppressed content does not materially affect the overall learning experience. Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it.
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