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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!