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Perfect Competition Continue

1) A firm should shut down in the short run if the price falls below the shutdown point, where revenues do not even cover variable costs. 2) In the long run, a firm will exit the market if price is insufficient to cover average total costs. 3) Under perfect competition, a firm's short-run supply curve is the portion of its marginal cost curve above the minimum of its average variable cost curve. The industry's long-run supply curve depends on whether costs are constant, increasing, or decreasing as output changes.

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Satakshi Singh
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31 views

Perfect Competition Continue

1) A firm should shut down in the short run if the price falls below the shutdown point, where revenues do not even cover variable costs. 2) In the long run, a firm will exit the market if price is insufficient to cover average total costs. 3) Under perfect competition, a firm's short-run supply curve is the portion of its marginal cost curve above the minimum of its average variable cost curve. The industry's long-run supply curve depends on whether costs are constant, increasing, or decreasing as output changes.

Uploaded by

Satakshi Singh
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© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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PERFECT

COMPETITION PART 2
When Firms should shut down
• A shutdown refers to a short-run decision not to produce anything
during a specific period of time because of current market conditions.
Exit refers to a long-run decision to leave the market.
• Shutdown rule: The shutdown point comes where revenues just cover
variable costs or where losses are equal to fixed costs.
• Profit, Loss, Shutdown. We can divide marginal cost curve into three zones,
based on where it is crossed by the average cost and average variable cost curves.
• We call the point where MC crosses AC the break even point.
• If the firm is operating where the market price is at a level higher than the break
even point, then price will be greater than average cost and the firm is earning
profits.
• If the price is exactly at the break even point, then the firm is making zero profits.
• If price falls in the zone between the shutdown point and the break even point,
then the firm is making losses but will continue to operate in the short run, since it
is covering its variable costs, and more if price is above the shutdown-point price.
• However, if price falls below the price at the shutdown point, then the firm will
leave immediately, since it is not even covering its variable costs.
Example
• A striking example of the shutdown rule at work was seen in the oil
industry. New oil wells are drilled by “oil rigs.” Each oil rig is like a little
business, which can operate or shut down depending upon profi
tability. When a price war broke out among oil producers in 1999,
many shut down, and the number of rigs in operation in the United
States declined to under 500. Had the oil fi elds run dry? Not at all.
Rather, production was discouraged because the price of oil was so
low. It was the profi ts, not the wells, that dried up. What happened
to drilling activity during the oil-price surge of the 2000s? From 2002
to 2008, when oil prices quadrupled, the number of rigs in operation
went up by a factor of almost 4.
Firms Supply curve in Perfect competition
short run
• “The Firm’s short period supply curve is that portion of its
marginal cost curve that lies-above the minimum point of the
average variable cost curve.”
• From fig. 1 it is clear that there is no supply if price is below OP.
At price less than OP, the firm will not be covering its average
variable cost. At OP price, OM is the supply. In this case, firms’
marginal revenue and marginal cost cut each other at A, OM is
equilibrium output. If price goes up to OP1, the firm will
produce OM1 output. This firm’s short run supply curve starts
from A upwards i.e., thick line AB.
LONG RUN – PRICE OUTPUT
DETERMINATION
Deriving Long run Supply Curve
• Constant-Cost Industry
A firm’s output choice is given in (a), while industry output is shown in
(b). Assume that the industry is initially in equilibrium at the
intersection of market demand curve D1 and short-run market supply
curve S1.
Point A at the intersection of demand and supply is on the long-run
supply curve SL because it tells us that the industry will produce Q1
units of output when the long-run equilibrium price is P1 .
To obtain other points on the long-run supply curve, suppose the
market demand for the product unexpectedly increases.
• Market demand curve from D1 to D2 . Demand curve D2 intersects
supply curve S1 at C. As a result, price increases from P1 to P2 . Part
(a) of Figure 8.16 shows how this price increase affects a typical firm
in the industry. When the price increases to P2 , the firm follows its
short-run marginal cost curve and increases output to q2 . This output
choice maximizes profit because it satisfies the condition that price
equal short-run marginal cost.
• As a result, in Figure 8.16 (b) the short-run supply curve shifts to the
right from S1 to S2 . This shift causes the market to move to a new
long-run equilibrium at the intersection of D2 and S2
• In a constant-cost industry, the additional inputs necessary to produce
higher output can be purchased without an increase in per-unit price.
This might happen, for example, if unskilled labor is a major input in
production, and the market wage of unskilled labor is unaffected by
the increase in the demand for labor. Because the prices of inputs
have not changed, firms’ cost curves are also unchanged; the new
equilibrium must be at a point such as B in Figure 8.16 (b), at which
price is equal to P1 , the original price before the unexpected increase
in demand occurred. The long-run supply curve for a constant-cost
industry is, therefore, a horizontal line at a price that is equal to the
long-run minimum average cost of production.
• In an increasing-cost industry the prices of some or all inputs to
production increase as the industry expands. For example, that the
industry uses skilled labor, which becomes in short supply as the
demand for it increases.

• long-run supply curve is upward sloping.

• Decreasing-cost industry Industry whose long-run supply curve is


downward sloping.

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