SECOND SEMESTER TOPIC COVERAGE SY 2023-2024 Trends, Networks, and Critical Th...
Shut down point and profit
1. Bellringer
On slates,
1. Identify the firm’s
short run variable
costs
2. Identify the firm’s
short run fixed costs
3.If 200 customers
show up, what is their
total revenue?
2. Exam review speed “dating”
• Desks in 2 rows facing each other, 10 sets
• 45 seconds each question, 17 minutes total
3. Have you ever seen this?
Why is this firm still open?
4. A C T I V E L E A R N I N GA C T I V E L E A R N I N G 22
Identifying a firm’s profitIdentifying a firm’s profit
4
Determine
this firm’s
total profit.
Identify the
area on the
graph that
represents
the firm’s
profit.
Q
Costs, P
MC
ATC
P = $10 MR
50
$6
A competitive firm
5. A C T I V E L E A R N I N GA C T I V E L E A R N I N G 22
AnswersAnswers
5
profit
Q
Costs, P
MC
ATC
P = $10 MR
50
$6
A competitive firm
Profit per unit
= P – ATC
= $10 – 6
= $4
Total profit
= (P – ATC) x Q
= $4 x 50
= $200
6. A C T I V E L E A R N I N GA C T I V E L E A R N I N G 33
Identifying a firm’s lossIdentifying a firm’s loss
6
Determine
this firm’s
total loss,
assuming
AVC < $3.
Identify the
area on the
graph that
represents
the firm’s
loss.
Q
Costs, P
MC
ATC
A competitive firm
$5
P = $3 MR
30
7. A C T I V E L E A R N I N GA C T I V E L E A R N I N G 33
AnswersAnswers
7
loss
MRP = $3
Q
Costs, P
MC
ATC
A competitive firm
loss per unit = $2
Total loss
= (ATC – P) x Q
= $2 x 30
= $60
$5
30
8. With partner
• Universal Widgets
• Has this cost structure:
• Quantity ATC
500 200
501 201
Your current level of production is 500 and the units are already
made
A new customer wants to buy an additional widget for $450, would
you sell it to them?
Consider marginal costs in your decision, you must calculate
total costs to find the answer ATC = TC/Q
so TC=AVC*Q
9. With partner
• Universal Widgets
• Has this cost structure:
• Quantity ATC TC = Q*ATC
500 200 100,000
501 201 100,701
Your current level of production is 500 and the units are already
made
A new customer wants to buy an additional widget for $450, would
you sell it to them?
Consider marginal costs in your decision, you must calculate
total costs to find the answer ATC = TC/Q
so TC=AVC*Q
10. FIRMS IN COMPETITIVE MARKETS 10
P1 MR
MC and the Firm’s Supply Decision
At Qa, MC < MR.
So, increase Q
to raise profit.
At Qb, MC > MR.
So, reduce Q
to raise profit.
At Q1, MC = MR.
Changing Q
would lower profit. Q
Costs
MC
Q1Qa Qb
Rule: MR = MC at the profit-maximizing Q.
11. FIRMS IN COMPETITIVE MARKETS 11
P1 MR
P2 MR2
MC and the Firm’s Supply Decision
If price rises to P2,
then the profit-
maximizing
quantity rises to Q2.
The MC curve
determines the
firm’s Q at any
price.
Q
Costs
MC
Q1 Q2
the MC curve is the
firm’s supply curve.
12. FIRMS IN COMPETITIVE MARKETS 12
Shutdown vs. Exit
• Shutdown:
A short-run decision not to produce anything
because of market conditions.
• Exit:
A long-run decision to leave the market.
• A key difference:
– If shut down in SR, must still pay FC.
– If exit in LR, zero costs.
13. FIRMS IN COMPETITIVE MARKETS 13
A Firm’s Short-run Decision to Shut
Down
• Cost of shutting down: revenue loss = TR
• Benefit of shutting down: cost savings =
VC (firm must still pay FC)
• So, shut down if TR < VC
• Divide both sides by Q: TR/Q < VC/Q
• So, firm’s decision rule is:
Shut down if P < AVC
14. FIRMS IN COMPETITIVE MARKETS 14
The firm’s SR
supply curve is
the portion of
its MC curve
above AVC.
Q
Costs
A Competitive Firm’s SR Supply Curve
MC
ATC
AVC
If P > AVC, then
firm produces Q
where P = MC.
If P < AVC, then
firm shuts down
(produces Q = 0).
15. 15
Sunk Costs
• Sunk cost: a cost that has already
been committed and cannot be
recovered
• Sunk costs should be irrelevant to
decisions; you must pay them
regardless of your choice.
• FC is a sunk cost: The firm must pay
its fixed costs whether it produces or
shuts down.
• So, FC should not matter in the
decision to shut down.
16. FIRMS IN COMPETITIVE MARKETS 16
A Firm’s Long-Run Decision to Exit
• Cost of exiting the market: revenue loss =
TR
• Benefit of exiting the market: cost savings =
TC
(zero FC in the long run)
• So, firm exits if TR < TC
• Divide both sides by Q to write the firm’s
decision rule as: Exit if P < ATC
17. FIRMS IN COMPETITIVE MARKETS 17
A New Firm’s Decision to Enter
Market
• In the long run, a new firm will enter the
market if it is profitable to do so: if TR >
TC.
• Divide both sides by Q to express the
firm’s entry decision as:
Enter if P > ATC
18. FIRMS IN COMPETITIVE MARKETS 18
The firm’s
LR supply
curve is the
portion of
its MC curve
above LRATC.
Q
Costs
The Competitive Firm’s Supply Curve
MC
LRATC
Rather than tell students that profit equals (P – ATC) x Q, this exercise requires students to figure it out for themselves.
If this exercise is too easy for your students, you can replace it with lecture slides that appear at the end of this file.
The height of the rectangle is P – ATC, profit per unit.
The width of the rectangle is Q, the number of units.
The area of the rectangle
= height x width
= (profit per unit) x (number of units)
= total profit.
Students that didn’t figure out the answer to the previous exercise should be able to get this one.
If this exercise is too easy for your students, you can replace it with lecture slides that appear at the end of this file.
Note that the statement “assuming AVC &lt; $3” is needed to prevent shut-down, i.e. to insure that the firm produces Q=30 instead of Q=0.
The height of the rectangle is ATC – P, loss per unit.
The width of the rectangle is Q, the number of units.
The area of the rectangle
= height x width
= (loss per unit) x (number of units)
= total loss.
This slide is similar to Figure 1 in the chapter. I’ve omitted the AVC and ATC curves (which appear in Figure 1 in the chapter) because they are not needed at this point.
The shutdown rule, in plain English, says:
If the cost of shutting down is less than the benefit, the firm should shut down.
In edit mode, it looks like the text boxes are on top of each other. But in presentation mode, the text boxes display only one at a time.
The decision rule for whether to exit says:
If the cost of exiting is greater than the benefit, the firm should exit.
Similarly, a prospective entrant compares the benefits of entering the market (TR) with the costs (TC), and enters if the benefits exceed the costs.