Long-Run
Cost Curves
Long-Run Average Cost
as the Envelope of Short-Run Average Cost Curves
Lower costs in the long run
• Because the firm cannot vary its capital in the
short run but can vary it in the long run,
short-run cost is at least as high as long-run
cost and is higher if the “wrong” level of
capital is used in the short-run.
• As a result, the long-run average cost is always
equal to or below the short-run average cost.
Long-Run and
Short-Run Expansion Paths
Chapter 8
Competitive Firms and Markets
Competition & Profit
Maximization
Competition
• Price taking
– Economists say that a market is competitive
if each firm in the market is a price taker
– Horizontal demand curve:
• The firm can sell as much as it wants at the
market price, so it has no incentive to lower its
price.
• The firm cannot increase the price because it
faces an infinitely elastic demand, A small
increase in price results in its demand falling to
zero.
Why the firm’s demand curve is horizontal
• Perfectly competitive market
– Identical products
– Freely enter and exit the market
– Buyers and sellers know the prices charged
by firms
– Low transaction cost
Why we study perfect competition?
• Many markets can be reasonably described as
competitive.
• A perfectly competitive market has many
desirable properties.
– Economists use this model as ideal against which
real-world markets are compared.
Profit Maximization
• A firm’s profit, π=R-C.
– If profit is negative π<0, the firm makes a loss
– Business use only explicit costs, Economist use
explicit and implicit cost (opportunity
cost)=Economic cost
• Economic profit = Revenue minus economic
cost, where economic cost includes any
additional opportunity cost
Two steps to maximizing profit
• Firm’s profit function
– π(q)=R(q)-C(q)
• To maximize profit, any firm must answer two
questions
– Output decisions
– Shutdown decisions
Output Rules
• Output rule 1: The firm sets its output
where its profit is maximized.
• Output rule 2: A firm sets its output
where its marginal profit is zero
• Output rule 3: A firm sets its output
where its marginal revenue equals its
marginal cost
Maximizing Profit