called marginal costs and are counted by dividing the change in total costs by the change in quantity.
All of these costs are represented in curves. Normally the marginal cost curve will be increasing, since normally marginal product decreases. Average total costs are usually U-shaped, because average fixed cost decline with quantity and average variable costs increase with quantity. The bottom of this U-shaped curve is often called the efficiency scale, since it represents the lowest possible average costs for the firm. If adding
another unit of production decreases average total costs than the average total cost curve is falling at that point, if adding an extra unit increases total costs then the curve is sloping upward. This means that where the marginal cost curve is below the average cost curve the ATC is falling and where the MC curve is above the ATC curve there the ATC is moving up. These curves cross at the minimum average total costs. This
represents the usual cost curves, but they are not necessarily so. For example marginal costs may decrease with added units due to economies of scale.
13.4. Costs in the Short Run and in the Long Run
Explanation and relationship between short-run and long-run average cost curves.
A firm cannot adjust the size of its factory and amount of machinery it has on a
day-to-day basis, in other words it cannot change its fixed costs in the short run, but it can do so in the long run. This is why the long run and short run average cost curves differ. The long run average cost curve is a much flatter U-shape and all of the short-run curves lie on top of it. When these long run curves decline with amount produced we say that there are economies of scale, which means that producing larger amounts is more efficient and cheaper than small amounts. If the opposite is true than we say that here are diseconomies of scale and that smaller amounts are optimal. If the long run curve is flat than we say that there are constant economies of scale.
run it will completely shut down if it cannot recover its fixed costs, because the price is less than average total costs. Also in the long run firms will have zero economic profit. Even though if demand increases in the short run there will be profits and also losses if demand decreases, due to free exit and entry, in the long run, there will be no profits.
14.1. What is a Competitive Market?
The basic assumptions of a competitive market are: free entry and exit, homogeneous products, profit maximization and price taking.
The assumptions of a competitive market are that: there are many sellers and buyers, firms are free to enter and exit the market without obstacle, all goods offered by all firms in a single market are the same. This implies that one firm cannot change the market price on its own. All of these firms try to maximize their revenue minus their costs so their profit. Average revenue is equal to the price of the goods, because revenue is price time’s quantity and average revenue is that divided by quantity.
Marginal revenue is an important concept; it is the increase in revenue divided by the increase in quantity. For competitive firms the marginal revenue equals the price.
14.2. Profit Maximisation and the Competitive Firm's Supply Curve
A firm will make a profit maximizing decision, where its supply curve (MC curve) crosses its marginal revenue curve.
As we have discussed previously an additional unit produced does not have the same cost as the previous unit necessarily. Normally at some point the costs start to increase with quantity. We’ve also mentioned that marginal revenue is equal to the price. So if a firm, to put it simply, wants to produce one more unit, the profit it is going to get from that good will be its marginal revenue or price minus its marginal cost. This brings us to three principles. First, when MR is greater than MC the firms should produce more.
Second, when MR is smaller than MC the firms should produce less. Third, when MR is equal to MC the firm is maximizing its profit and should keep producing that amount.
Regardless of where the firm starts out it should eventually come to the profit maximizing quantity. The firms, if competitive, is willing to sell its product for its marginal cost so MC=P. and since MC=P=MR at a profit maximizing point, the firms marginal cost curve is also its supply curve.
However, there is a difference between the short and long runs. As we know the firm
lOMoARcPSD|23100697
cannot avoid paying its fixed costs in the short run, but can do so in the long run. So the firms will not produce anything in the short run if its total revenue is less than its variable costs, not its total costs though, because it would still need to compensate for fixed costs of possible. Therefore the firm’s short run supply curve is the part of the marginal cost curve that is above the average variable cost curve. Or in other terms if the price is less than the average variable costs. On the other hand, in the long run the firm should only shut down if its total revenue is less than its total costs, or the price is less than its average total costs. To turn this around, we can also say that an
entrepreneur should enter a market if he knows that his start up will be able to have average total costs that are less than the market price. The total profit is going to be the firm’s total revenue minus its total costs, or, to make it simpler, the price minus average total cost times quantity.
14.3. The Supply Curve in a Competitive Market
The long run market supply curve due to firm entry and exit is normally a perfectly elastic horizontal line at the point of minimum average total costs.
To derive the market supply curve lets first consider a very simplified situation of a competitive market with no exit or entry. Since here all the firms are the same the market supply at a given price will be one firms supply times the number of firms.
However in the long run when firms can enter and exit, if the market is profitable new companies will enter, expand supply and hence reduce the price and profits. Conversely if the market is making losses some firms will exit, contract supply and hence raise the price and profits, at the end of this process firms that remain in the market must be making zero economic profit and their price must be equal to their total average costs.
So in the long run there can be only one price, since only one price means zero economic profit and it is equal to the minimum total average costs. This can be represented in a horizontal line parallel to the x-axis, which is the long run perfectly elastic market supply curve. Even if demand changes cause profits or losses (depending on the direction of the shift), they only persist in the short term and in the long run due to entry and exit firms earn zero economic profit. However, long run supply curves can also be upward slopping. Firstly, if the market requires a limited resource, expanded demand for that resource will increase its price and hence the cost of the good it is being used to make. Secondly, different sellers may have different costs, which means
lOMoARcPSD|23100697