The GenericCostCurve-The Short-Run(SR)
Although the graphed curves on the right use exactly the same
information as the table on the left, they are more useful. The
curves are called the marginal cost curve (MC), the average
total cost curve (ATC), and the average variable cost curve
(AVC).
Quantity
(pianos
movedTotalFixedVariableAverageAverage AverageMarginalDOLIJ\l!S
Cost 50
le
al CostFixed
Cost Variab
perday) CostsCostsCostsTot
0
)
(AVC) (MC
(Q)
(TC) (FC) (VC) (ATC) (AFC) Cost
0
1
2
3
4
5
6
7
8
9
10
11
300 300
450 300
570 300
670 300
780 300
900 300
1,040300
1)00 300
1,390300
1,640300
1,960300
2A60300
lrc
"rc~
Page1
0
150
270
370
480
600
740
900
1,090
1,340
1,660
2,160
450
285
223
195
180
173
171
174
182
196
223
300
150
100
75
60
50
43
38
33
30
27
150
135
123
120
120
123
128
136
149
166
196
150
120
100
110
120
140
160
190
250
320
500
400
Marginal
cost(MC)
'
300
Averag
e
lotalcosl
(ATC)
200
AY
erage
variable
cost(AVG)
............
100
IAr~I1~~11!~1
Chan9e
inTC
Change
inQ
..
...........
0
2
3
4
5
G
7
8
n
10 11
Qt1ANT
l1'Y
The GenericCostCurve-The Short-Run(cont.)
The relationship between marginal and average allows us to
sketch a generic cost curve diagram which characterizes virtually
all firms. Again, we are now focusing on individual firms in a
competitive market, not markets themselves. Note that the
marginal cost curve (MC) cuts both the average variable cost
(AVC) curve and the average total cost curve (ATC) at their
minimum points. Also note the flat demand (D) curve added in
whose intersection with the MC curve establishes the equilibrium
price (Pe) and equilibrium quantity (Qe).
Price
AFirm
.1
v c (S)
Equilibrium
price (Pe), -....,..__........,.~---------demand (D),
marginal
benefit (MB),
and marginal
revenue (MR)
.......----
I
I
I
I
I
I
Profit maximizing quantit~:
Equilibrium
quantity (Qe)
Quantity
Page2
Microeconomics Do-Now
Please do this:
1. Draw a generic cost curve for firms and include the
demand curve and the profit maximizing point.
Page3
The GenericCostCurve-The Short-Run(cont.)
Notice that the distance between the average total cost (ATC)
curve and the average variable cost (AVC) curve gets smaller
as production increases because fixed costs (FC) are a smaller
proportion of total costs (TC) as production increases .
D<H.
..LAH .
1l/ C
A1C
A t1V
Page4
Costsand Production:The Short-Run
The level of production for a competitive firm with generic
cost curves as we just studied is shown below. The quantity
produced is determined by the intersection of the marginal cost
(MC) curve and the market price line (P), which is also the
demand (D) curve for competitive firms because they are
price-takers. Their prices are perfectly elastic. We draw a
dashed vertical line to mark the quantity (Q) produced.
AFirm
Price
Pe, D, MB,
and MR
Profit©
7
MCandS
ATC
Total
revenu
AVC
(TR)
revenue
= $60 (10 X $6)
Page5
1
2
3
4
Profit maximizing quantitY'.
5
6
7
8
9
10
Equilibrium
quantity (Qe)
Quantity
The Profitor 1,ossRectangle
Profits equal total revenue (TR) minus total costs (TC). To
calculate profits by using a graph, we need to represent the
total revenue and total costs on the graph. Because the width
of this rectangle is the quantity produced (Q) and the height of
this rectangle is the market price (P), the area is P x Q, or total
revenue. Below, the total revenue is $60, but then you must
calculate the total costs (the area from ATC down, $40) to
determine profit, which is $20 (TR$60- TC$40==$20).
A Firm
Price
Pe, D, MB,
and MR
Total
revenu
(TR)
MCandS
7
Total( s
profit 41------
.....iiiiilllll~
-----~.....,......._
~
~
Total 3
cost 2
(TC) 1
revenue
= $60 (10 X $6)
Page6
Profit ©
1
2
3
4
Profit maximizing quanti~
5
6
7
8
9
10
ATC
AVC
Equilibrium
quantity (Qe)
Quantity
The Profitor 1,ossRectangle(cont.)
Observe the point where the average total cost (ATC) curve
intersects the dashed vertical line, the quantity supplied (Qs). This
point tells us what the firm's average total cost is when it produces
the profit-maximizing quantity. The area of the rectangle with the
hash marks shows the firm's total costs. If the firm chose to
increase its price (P) in order to increase its revenue, its revenue
would fall massively or fall to "O" because the firm's customers
will go elsewhere because the firm has no market power; it is a
price-taker and its price perfectly elastic.
A Firm
Price
Profit ©
Pe, D, MB,
and MR
Total
revenu
(TR)
total pro it=
O $60-$40)
ATC
AVC
l costs==
40 10 X ~ -~:::::-----
Total 3
cost 2
(TC) 1
revenue
~ $60 (10 X $6)
Page7
MCandS
Profit maximizing quantitY'.:
1
2
3
4
5
6
7
8
9
•''
:
•
~
10
Equilibrium
--
quantity (Qe)
Quantity
Profitsor 1,osses?
Since profits are total revenue (TR) less total costs (TC), we
compute profits by looking at the difference between the two
rectangles, in this case, both combined (revenue) minus the one
on the bottom, total costs. The difference is itself a rectangle,
shown by the part of the rectangle that rises above the total
costs rectangle. Profits are positive because total revenue is
greater than total costs.
AFirm
Price
Profit©
Pe, D, MB,
and MR
MCandS
total pro it=
Total
revenu
(TR)
O $60-$40)
revenue
= $60 (10 X $6)
Page8
••
•
Total 3
cost 2
(TC) 1
:
~-----------~
1
2
3
4
Profit maximizing quantify,.)~
v
5
6
7
8
9
10
_
Equilibrium
quantity (Qe)
--
Quantity
Profitsor 1,osses?(cont.)
Now comes the rough part, losses. The market price (P) is at the
intersection of the marginal cost curve (MC) and the market price
line. The intersection of MC and the market price line also gives
you the loss-minimizing price and quantity because supply (S) and
demand (D) are at equilibrium. At this quantity of production (Q),
the per-unit price or average total cost (ATC) is above the price,
and there will be a loss in profit because the total costs (TC) are
more than the total revenue (TR).
A Firm
Price
Losses ®
(TR)
total
revenue=
$28 (7 X $4)
6
5
4 ~~.......,.. ~~
--
........
~ ~~~
•
'
2
1
total revenue-- •I
$28 (7 X $4) ;
2
3
ATC
AVC
~
......iiiiii.~
.......
--""'
..........
___
3
1
Page9
(Me)
~---~-~
Total
costs
(TC)
s
Market
equilibrium
7
Total
revenue
MC and
4
5
6
7
--.,Pe,
D, MB,
andMR
Equilibrium
quantity (Qe)
Quantity
Profitsor 1,osses?(cont.)
The intersection of MC and the market price line indicates the
allocatively efficient price and quantity that is best for society.
Between that intersection and the intersection of the average
total cost curve (ATC) and the profit-maximizing quantity
produced is the area of loss.
Pricel
AFirm
Losses®
Total
reve nue
(TR)
tota l
reven ue =
$28 (7 X $4)
Ma rket
equilibrium
7
6
otal
costs
(TC)
5
4~
3
(Me)
~
;;..;..:
sz:;.....;;;.~ ~:;.._~
;....;;~
•
......al!!
.....-=:~ --.,
E q Ul·1·b
.
total revenue - ':
I r1um
$28 (7 x $4) :.---::::quantity (Qe)
2
1
3
Page10
MCandS
4
5
6
7
Pe, D, MB,
and MR
Qu antity
Microeconomics Do-Now
Please do this:
1. Draw two graphs, one showing short-run profits in a
firm and one showing short-run losses in a firm.
2. On either graph, show a shift in the supply curve above
the ATC. State the impact of the shift on the profit or
losses of the graph you used.
Page11
The BreakevenPoint
Now draw the market price (P) line through the point where
the marginal cost curve (MC) intersects the average total cost
curve (ATC). This is the breakeven point , minimum point on
the average total cost curve. At that price, the firm chooses a
quantity for which average total cost equals the price. The
total revenue rectangle and the total cost ( TC) rectangle are
exactly the same. There are zero economic profits.
Equilibrium Price
price (Pe),
demand (D),
marginal
benefit (MB),
and marginal
revenue (MR)
Total
revenue
(TR)
Page12
Total
= costs
(TC)
A Eirm
Breakeven
point
MCandS
ATC
AVC
~~~~~.
Equililirium
j/quantity
Q
Quantity
Profits = 0 / Breakeven = (P = ATC)
(Qe)
The BreakevenPoint(cont.)
Thus, the difference between their areas is zero. At that price
(P), the firm is at a breakeven point: P ==ATC, and economic
profits are zero. Notice that as demand (D) increases (P to Pl),
it shifts up along the supply(S)/marginal cost (MC) curve.
Equilibrium
Price
A Firm
Breakeven
point
price (Pe),
demand (D),
marginal
benetit (MB) ,
and marginal
revenue (MR)
otal
revenue
(TR)
Total
= costs
(TC)
MCandS
ATC
AVC
~----.......
--~~ --r.
_________
,
I/q
_
Q
Equilibrium
uanti ty (Qe)
Quant1ty
.
Profits = 0 / Breakeven = (P = ATC)
Page13
The BreakevenPoint(cont.)
The firm earns positive profits if the price is greater than the
breakeven point (P > ATC), as shown below.
Price
Pe,D, 1\lB,
andMR 7
Total
revenu
(TR)
Page14
AFirm
Profit©
MCandS
The BreakevenPoint(cont.)
The firm has negative profits (a loss) if the price is lower than
the breakeven point (P < ATC) , as shown below. The case of
negative profits raises the question of why a firm does not shut
down. By continuing operations, the firm can minimize its
losses.
Price I
AFirm
Losses®
Market
equilibrium
7
(TR)
tota l
revenue =
$28 (7 X $4)
(Me)
6
Total
revenue
costs
(TC)
5
4 ~ ~ :;...;..:~
...:;.~ ~~~
~ -=-~ .....-::::;.....
--,.
:
3
2
$28 (7 x $4)
3
4
5
6
Pe, D, MB,
and MR
Equilibrium
:.-----quantity (Qe)
7
Qu antity
total revenue - :
1
Page15
MCandS
The
Breakeven
Point-Questions
10 . A ss urn e tha t a pr ofit -maximi zin g, perf ec tly
comp etiti ve firm has eco nomi c losses in the
short run . If th e firm continu es to pr odu ce and
se ll its goo d , th e n w hi ch of the fo llow in g mu st
be tru e?
(A ) Th e firm is cove rin g a ll of its fix ed and
variabl e cos ts of pr odu ction .
(B ) Th e firm is cove rin g all of its fix ed cos ts but
no t a ll of its va riab le cos ts of pr odu ction.
(C) Th e firm is cove rin g a ll of its va ria ble cos ts
but no t a ll of its fi xed co ts of pr odu c tio n .
(D ) Th e firm is cove ring a ll of its itnpli cit co t
but no t a ll of its exp licit cos ts.
(E ) Th e firm mu st have ra ised th e pri ce of its
goo ds in ord e r to minimi ze its losses .
9 . Supp o se th at price in a perfec tly co mp etitive
indu stry dec rea es and it is now below minimum
ave r age to tal cos t but rem ain s abo ve m inimum
ave rage var iabl e cost. Whi ch of the followin g will
occ ur in th e hort run ?
(A ) N ew fi rm s will ent er the indu stry .
(B ) Firm s will in crease o utput so that mar g inal
reve nu e eq uals th e new p rice.
(C) Firm s will pro duce the o utput at w hi ch
ave rage total cos t i at a minitnum .
(D ) Firm s will p rodu ce the o utp ut at whi ch
marg inal co st equal s th e new pr ice.
(E) Firm s will not pr odu ce at all . ince th ey will
be unable to cover all their c o ts.
Page16
The
Breakeven
Point-Questions
10 . A ss urn e tha t a pr ofit -maximi zin g, perf ec tly
comp etiti ve firm has eco nomi c losses in the
short run . If th e firm continu es to pr odu ce and
se ll its goo d , th e n w hi ch of the fo llow in g mu st
be tru e?
(A ) Th e firm is cove rin g a ll of its fix ed and
variabl e cos ts of pr odu ction .
(B ) Th e firm is cove rin g all of its fix ed cos ts but
no t a ll of its va riab le cos ts of pr odu ction .
•
Th e firm is cove rin g a ll of its va ria ble cos ts
but no t a ll of its fi xed co ts of pr odu c tio n .
(D ) Th e firm is cove ring a ll of its itnpli cit co t
but no t a ll of its exp licit cos ts.
(E ) Th e firm mu st have ra ised th e pri ce of its
goo ds in ord e r to minimi ze its losses .
9 . Supp o se th at price in a perfec tly co mp etitive
indu stry dec rea es and it is now below minimum
ave r age to tal cos t but rem ain s abo ve m inimum
ave rage var iabl e cost. Whi ch of the followin g will
occ ur in th e hort run ?
(A ) N ew fi rm s will ent er the indu stry .
(B ) Firm s will in crease o utput so that mar g inal
reve nu e eq uals th e new p rice.
(C) Firm s will pro duce the o utput at w hi ch
ave rage total cos t i at a minitnum .
Firm s will p rodu ce the outp ut at w hi ch
marg inal co st equal s th e new pr ice.
(E) Firm s will not pr odu ce at all . ince th ey will
be unable to cover all their c o ts.
Page17
The ShutdownPoint
The firm should shut down if the price (P) falls below the
minimum point of the average variable cost curve (AVC) and is
not expected to rise again, which is ref erred to as the
shutdown point. When total revenue is less than the average
variable costs (AVC), it makes sense to stop producing, as
shown below.
AFirm
Price
Equilibrium
price (Pe),
demand (D),
marginal
benefit (MB),
and marginal
revenue (MR)........,.
p
Shutdown
point
MCandS
ATC
AVC
~ ----=
= ~=====!
,~ =::::::::
:..._
__
'•
Q
(
Quantity
Profits are negative and P is less than AVC
shutdown= (P < AVC)
Page18
The ShutdownPoint(cont.)
The graph below shows the case where the price is below the
average variable cost (P < AVC) and the firm should shut
down. However, if the price is above average variable cost (P
> AVC), the firm should not shut down, even if the price is
below average total cost and profits are negative. As long as
the price (P) is above the average variable cost (AVC), the firm
will produce a quantity such that marginal cost (MC) equals the
price.
AFirm
•
Price I
Equilibrium
price (Pe),
demand (D),
marginal
benefit (MB),
and marginal
revenue (MR) --..
Shutdown
point
MCa ndS
ATC
AVC
p
~ ---=
= ~== ~ ,~E::::::=--'
(
-
Q
Quantity
Profits are negative and P is less than AVC
shutdown= (P<AVC)
Page19
The ShutdownPoint-Questions
24. For a perfectly co1npetitive firm producing the
profit-rnaxitnizing quantity the average total co t
i $10 and th averag variable cost i $8. If th
n1arket price for it product i $10 which of the
following is true for the firm?
(A) It i u taining a lo and should shut down.
(B) It i earning zero economic profit and will
re1nain in bu ine .
(C) Its accounting profits exceed itnplicit costs.
(D) It will te1nporarily shut down until price rise .
(E) It i rnaking an economic profit that will
attract other firms to the indu try.
52. A profit-1naximizing finn will hut down in the
hort run any time th firm" total r venue i I
than it
(A) total co t
(B) fix d cost
(C) total variabl· co t
(D) exolicit co t
Page20
The ShutdownPoint-Questions
24. For a perfectly co1npetitive firm producing the
profit-rnaxitnizing quantity the average total co t
i $10 and th averag variable cost i $8. If th
n1arket price for it product i $10 which of the
following is true for the firm?
(A) It i u taining a lo and should shut down.
(e ) It i earning zero economic profit and will
re1nain in bu ine .
(C) Its accounting profits exceed itnplicit costs.
(D) It will te1nporarily shut down until price rise .
(E) It i rnaking an economic profit that will
attract other firms to the indu try.
52. A profit-1naximizing finn will hut down in the
hort run any time th firm" total r venue i I
than it
(A) total co t
(B) fix d cost
. ) total variabl· co t
(D) exolicit co t
Page21
The ShutdownPoint-Questions
52. In the hort run if a firrn produce the I vel of
output at which rnarginal revenue i equal to
than av rage
marginal co t but price i l
total co t th· firm will
(A alway hut down production
(B xpand output to lower it average fixed co t
(C continu t operate if pric i great r than it
averag variabl co t
(D deer a output until pric equal it average
total co t
(E increa e output to increa revenue
Page22
The ShutdownPoint-Questions
52. In the hort run if a firrn produce the I vel of
output at which rnarginal revenue i equal to
than av rage
marginal co t but price i l
total co t th· firm will
(A alway hut down production
(B xpand output to lower it average fixed co t
continu t operate if pric i great r than it
averag variabl co t
(D deer a output until pric equal it average
total co t
(E increa e output to increa revenue
<
•
Page23
The ShutdownPoint(cont.)
Economists have developed the concept of sunk cost, which
may help you understand and remember why a firm would
continue to operate in the short run even though it was
reporting losses. A sunk cost is a cost that you have
committed to pay and that you cannot recover. Rental
payments are an example of a sunk cost. The important thing
about a sunk cost is that once you commit to it, there is nothing
you can do about it, so you might as well ignore it in your
decisions.
Page24
Microeconomics Do-Now
Please do this:
1. Draw a graph showing a firm at the breakeven point and
another graph showing the shutdown point.
Page25