Cost Curves & Competitive Markets Test UNIT TEST #2 Block 3/1st or 2nd MULTIPLE CHOICE & FREE RESPONSE DUE: STUDY GUIDE #2 One Individual Firm Price ATC MC E1 AVC P 1 D = MR ------------ Q1 Quantity (firm)

Entire Market 1-Individual Firm All Firms maximize profit by setting MR = MC (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: P < ATC Stay open if: P ≥ ATC Entire Market 1-Individual Firm Price Price MC ATC S 1 D1 A AVC ------------------ 1 Q A D = MR $20 $20 ------------- Quantity (market) Q 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 Entire Market One Individual Firm Price Price ATC MC S Short-run supply, 1 D Demand, 1 AVC 1 Q A Long-run supply, D = MR P 1 P 1 Quantity (market) Quantity (firm) Must produce at Efficient Scale Production = (min of ATC) Economic profit = ZERO P = MC = ATC = MR

Short Run Increase in Demand Increase in market demand => ↑ price & quantity Firms produce more & earn a short run profit Entire Market 1- Individual Firm Price Price D 2 MC S 1 ATC Q2 B Q 2 P B D 1 D2 = MR2 P 2 profit Q 1 A Q 1 A P1 P 1 D1 = MR1 Quantity (market) Quantity (firm) This is not a long run equilibrium!

Long Run Equilibrium Economic Profit induces new firms to enter market => supply increases Entire Market 1 Firm Price Price D 2 MC S1 ATC B B Q2 P2 S 2 D2 = MR2 A P 2 Q 1 A Q3 P3 Long-run Market supply Q 3 C D3=MR3 C P D1=MR1 1 P 1 Market long run supply curve is perfectly elastic because of unlimited entry/exit into the marketplace at minimum of ATC 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 D1 Q1 Q2 Quantity (market) Quantity (firm)

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!