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TR, TC
and profit graphically
Marginal m
ethod for maxim
izing profit
• Put M
C and M
R together
• Have from
perfect competition and the
market price the M
R curve (horizontal)
• And have the M
C curve shape from
the previous chapter
MR
, MC
and profit maxim
ization graphically
What w
e just did: the general rule
– If MR
> MC
, the extra revenue from
selling one more unit exceeds the extra
cost incurred to produce it. – E
conomic profit increases if output
increases.
– The opposite holds if MC
> MR
.
First decision made: found the
profit maxim
izing level of output
This is the best the firm can do.
But, is it good enough?
What is profit at this profit m
aximizing
point?
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The second decision: stay open or shut dow
n
• Temporary S
hutdown D
ecisions – If a firm
is incurring an economic loss that
it believes is temporary, it w
ill remain in the
market, and it m
ight produce some output
or temporarily shut dow
n.
Why fixed and variable costs are
important
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Decision rule for shutting dow
n
So the firm
produces some output if P > AV
C
but shuts down tem
porarily if AVC
> P
Because by producing any output at all it
increases its losses.
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What if econom
ic profit > 0?
Happens because P > ATC
at level of output w
here P (MR
) = MC
. W
hat does this signal to other potential firm
s? H
ow does this lead to econom
ic profit in com
petition always = 0?
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Role of entry and exit
– The imm
ediate effect of the decision to enter or exit is to shift the m
arket supply curve.
– If more firm
s enter a market, supply
increases and the market supply curve
shifts rightward.
– If firms exit a m
arket, supply decreases and the m
arket supply curve shifts leftw
ard.
Dem
and also plays a role
– A decrease in demand triggers a sim
ilar response, except in the opposite direction.
– The decrease in demand brings a low
er price, econom
ic loss, and some firm
s exit.
– Exit decreases m
arket supply and eventually raises the price to its original level.
The role of technology: two forces
1. Firms that adopt the new
technology make
an economic profit.
New
-technology firms have an incentive to
enter. 2. Firm
s that stick with the old technology
incur economic losses.
These firms either exit the m
arket or switch
to the new technology.