Course information
 Finishing costs and starting profit
maximization in perfect competition
 Homework due this Sunday night
 Midterm Wednesday April 4 in class. Bring
#2 pencils and calculators. Covers chapters
on consumer choice/equilibrium and
production costs
Diseconomies of scale
A firm increases plant size and labor employed by the same
percentage
Output increases by a smaller percentage
Average total cost increases
Why? Difficulty of coordinating and controlling a large enterprise.
Eventually, management complexity brings rising average total
cost.
Constant returns to scale
A firm increases its plant size and labor employed by the
same percentage
Output increases by the same percentage
Average total cost remains constant.
Why? A firm is able to replicate its existing production facility
including its management system.
What this looks like
The long-run average cost curve
shows the lowest average cost at which it is possible to
produce each output
when the firm has had sufficient time to change both its
plant size and labor employed.
Long-run average cost curve
Can vary all inputs to change the size (scale)
With its current
plant, Sam’s ATC
curve is ATC1.
With successively
larger plants,
Sam’s ATC curves
would be ATC2,
ATC3, and ATC4.
EYE on RETAILERS COSTS
Which Store Has the Lower Costs:
Wal-Mart or 7–11?
Wal-Mart’s “small” supercenters measure 99,000 square
feet and serve an average of 30,000 customers a week.
The average 7–11 store, mostly attached to gas stations,
measures 2,000 square feet and serves 5,000 customers a
week.
Which retailing technology has the lower operating cost?
The answer depends on the scale of operation.
At a small number of customers per week, it costs less per
customer to operate a store of 2,000 square feet than a
store of 99,000 square feet.
EYE on RETAILERS COSTS
Which Store Has the Lower Costs:
Wal-Mart or 7–11?
The average total cost curve of operating a store of 2,000
square feet is ATC7–11.
The average total cost curve of a store of 99,000 square
feet is ATCWal-Mart.
The dark blue curve is a retailer’s LRAC curve.
EYE on RETAILERS COSTS
Which Store Has the Lower Costs:
Wal-Mart or 7–11?
With Q customers a week, the average total cost of a
transaction is the same in both stores.
For a store that serves fewer than Q customers a week, the
least-cost method is the small store.
Profit maximization in perfect competition
 What is profit? TR –
TC
 What is perfect
competition? No
consumer or
producer can
influence the market
price – all price
takers
Concentration in US manufacturing: All companies
Concentration ratios by sector
Concentration ratios by sector continued
Maximizing profit
How to do it?
2 methods: TR & TC and MR & MC
Maximize profit where
1.  maximize difference between TR and
TC or (equivalently)
2.  MR = MC
Slope of the MR curve
 MR is the price paid for each additional
unit
 Constant because of perfect competition
 Market price is given to all firms
 Can only sell at that price no matter how
much they sell
Slope of the TR curve
 Constant because MR is constant
 MR constant because of perfect
competition where firm is a price
taker
 Graph of the TR curve is a
straight line
The revenue side – marginal revenue
The revenue side – total revenue
Marginal and total revenue
MR comes from market price.
The table shows the calculations of TR and MR.
Finding maximum profit with TR and TC
Profit is maximized at the output level at which
TR revenue exceeds TC by the largest amount.
Why? Because total profit = total revenue –
total cost
Have TR: now need to add TC. We have seen
the shape of this in the previous chapter, so
nothing new here!
TR, TC and profit graphically
Second approach: Profit maximization through MR
and MC rather than TR and TC
If MR > MC, the extra revenue from selling one
more unit exceeds the extra cost incurred to
produce it.
Economic profit increases if output increases.
The opposite holds if MC > MR.
Profit maximizing level of putput
 Put MC and MR together
 Have from perfect competition and the
market price the MR curve (horizontal)
 And have the MC curve shape from the
previous chapter
MR, MC and profit maximization graphically
First decision: find the profit maximizing output
This is the best the firm can do.
But, is it good enough?
What is profit at this profit maximizing point?
Profit maximizing equilibrium: Add AC
The second decision: stay open or shut down
 Temporary Shutdown Decisions
If a firm is incurring an economic loss that it believes
is temporary, it will remain in the market, and it
might produce some output or temporarily shut
down.
What happens and why fixed and variable costs
are important
1. If the firm shuts down temporarily, it incurs an
economic loss = TFC.
2. If the firm produces some output, it incurs an
economic loss equal to TFC + TVC – TR.
3.  If TR > TVC, the firm’s economic loss is less
than TFC.
4.  So it pays the firm to produce and incur an
economic loss. It can pay some of TFC even if
not all.
Decision rule for shutting down
So the firm produces some output if P > AVC
but shuts down temporarily if AVC > P
Because by producing any output at all it increases its
losses.
Shutdown point
The output and price at which price equals
minimum average variable cost.
Below that point can’t set aside anything to
cover fixed costs.
Better to shut down.
Shut down point graphically