|Shutdown versus Investment
|The Shutdown Decision
- Fixed costs must be paid even if all output ceases.
- A firm should shut down only if total revenues are less
than total variable costs.
- Price versus AVC
- Where price exceeds average variable cost but not average
total cost, the profit maximum actually minimizes losses.
- The Firm’s Shutdown Point
- That rate of output where price equals minimum AVC.
- When price does not cover average variable costs at any
rate of output, production should cease.
|The Investment Decision
- The decision to build, buy, or lease plant and equipment;
to enter or exit an industry.
- Investment decisions are long-run decisions (i.e., a period
of time long enough for all inputs to be variable)
- Long-Run Costs
- A producer will want to build, buy or lease a plant that
is most efficient for the anticipated rate of output.
|Determinants of Supply
The marginal cost curve is the short-run supply curve for a
Supply Curve – a curve describing the quantities of a good
a producer is willing and able to sell (produce) at alternative prices
a given time period, ceteris paribus.
Supply Shifts - If any determinant of supply changes, the
supply curve shifts.
- The price of factor inputs
- Technology (the available production function)
- Expectations (for costs, sales, technology)
- Property taxes.
- property taxes are a fixed cost
- they don't affect the MC curve
- they raise ATC thus reducing profits
- lower profits may alter investment decisions (a long-run
- payroll taxes increase marginal costs and
thus, reduce the optimal level of output
- they shift the MC curve
- therefore ATC must shift as well
- they lower total and per-unit profits
- profit taxes are neither a fixed or variable cost
- they do not affect marginal costs or prices
- do not affect production level decisions but may affect
POINT -- tax policy affects production and
|The Market Supply Curve
- Equilibrium price – The price at which the quantity of a
good demanded in a given time period equals the quantity supplied.
- Market supply – The total quantities of a good that sellers
willing and able to sell at alternative prices in a given time period,
- The market supply curve is the sum of the marginal
cost curves of all the firms
- the market supply of a competitive industry is determined
- The price of factor inputs
- The number of firms in the industry
|Entry and Exit
- Investment Decision - The decision to build, buy, or
lease plant and equipment; to enter or exit an industry.
- The investment decisions shift the market supply curve to
- The profit motive drives these investment decisions.
|Tendency Toward Zero
- Economic profits – The difference between total revenues
and total economic costs.
- An increase in market supply causes the economic profits to
- When economic profits disappear, entry ceases and the
market price stabilizes.
- Competitive market - A market in which no buyer or seller
has market power.
- As long as it is easy for existing producers to expand
or for new firms to enter an industry, economic profits will not last
|Low Barriers to Entry
- Barriers to entry – obstacles that make it difficult or
for would-be producers to enter a particular market, such as patents.
- Barriers to entry may include:
- Control of essential factors of production.
- Control of distribution outlets.
- Well-established brand loyalty.
- Government regulation.
of Perfect Competition
- Some of the structures, behaviors and outcomes of a
competitive market are:
- Many firms
- Perfect information
- Identical products
- MC = PRICE = MR (all competitive firms will
to expand output until marginal cost is equal to the market price of
product being produced)
- Low barriers to entry
- Zero economic profit
|Relentless Profit Squeeze
- The sequence of events common to a competitive market
- High prices and profits signal consumers’ demand for more
- Economic profit attracts new suppliers.
- The market supply shifts to the right.
- Prices slide down the market demand curve.
- A new equilibrium is reached with increased quantities
being produced and sold and the economic profit approaching zero.
- Throughout the process, producers experience great
to keep ahead of the profit squeeze by reducing costs, a pressure that
results in product and technological innovation.