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Cost Curves & Competitive Markets Test
UNIT TEST #2
Block 3/1st or 2nd
MULTIPLE CHOICE & FREE RESPONSE
DUE: STUDY GUIDE #2
Price
One Individual Firm
MC
E1
ATC
AVC
P1
------------
D = MR
0
Q1
Quantity (firm)
• All Firms maximize profit by setting MR = MC
Price
(they are “price takers”)
SHORT RUN FIRM Supply Curve:
•
•
Shutdown if P < AVC
Stay open if P ≥ AVC
LONG RUN FIRM Supply Curve:
•
•
Exit market if:
Stay open if:
Entire Market
Price
P < ATC
P ≥ ATC
1-Individual Firm
MC
S1
------------------
$20
D1
0
Q1
Quantity (market)
0
-------------
$20
A
A
Q
ATC
AVC
D = MR
Quantity (firm)
Efficient Scale Production
• Efficient scale- the quantity of output that minimizes ATC
– Production point in long run for all competitive firms
– Where MC = ATC
– Economic profit = 0 [Profit = (P – ATC) * Qty]
-----------
Long Run Equilibrium
Price
Entire Market
Price
One Individual Firm
MC
Short-run supply, S1
A
P1
Long-run supply,
P1
ATC
AVC
D = MR
Demand, D1
0
Q1
Quantity (market)
0
Must produce at Efficient Scale Production = (min of ATC)
Economic profit = ZERO
P = MC = ATC = MR
Quantity (firm)
Short Run Increase in Demand
Increase in market demand =>
Firms produce more &
↑ price & quantity
earn a short run profit
Entire Market
1- Individual Firm
Price
Price
B
P2
P1
B
S1
P2
A
P1
MC
ATC
D2 = MR2
profit
A
D1 = MR1
D2
D1
0
Q1
Q2
Quantity (market)
0
Q1
Q2
Quantity (firm)
This is not a long run equilibrium!
Long Run Equilibrium
Economic Profit induces new firms to enter market => supply increases
Price
Entire Market
Price
1 Firm
MC
S1
B
P2
A
C
P3 P1
S2
Long-run
Market supply
B
P2
P3 P1
CA
ATC
D2 = MR2
D1=MR1 D3=MR3
D2
D1
0
Q1
Q2
Q3
Quantity (market)
0
Q1 Q2
Q3
Quantity (firm)
In the long run market price is restored to min. of ATC!
But total market supply is greater Q3 as more firms are in market
Market long run supply curve is perfectly elastic because of unlimited entry/exit
into the marketplace at minimum of ATC
Practice Test
Short Run vs. Long Run Costs
• Costs depends on time horizon considered
– In the short run, some costs are fixed
– In the long run, all fixed costs become variable costs
• Why: Firms have time to change both plant size & labor force
• long-run cost curves differ from short-run cost curves
• LRATC is always below or on short run ATC curve
– you can be more efficient in long run!
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