1. Short Run Equilibrium In Perfect Competition Lecture 19
Dr. Jennifer P. Wissink
©2019 Jennifer P. Wissink, all rights reserved.
April 8, 2019

2. So What?
The 7 short run cost curves will still look and feel and hang together the same way.
We just now know that if there is more than one variable input behind the scenes, the plant manager has successfully carried out the cost minimization exercise correctly and has equated the bang/buck across all his variable inputs.
In this way we derive the “best” or “minimum” cost functions.
THE COST GRAPH

3. About The Cost Graph
Does The Cost Graph always look exactly like this?
NO!
But some things will always be true.
Suppose
Joe’s fc=$100 and Joe’s vc=q2

4. END OF MATERIAL FOR PRELIM 2
Thank goodness!
But we keep using costs, so going forwards reviews and at the same time starts new stuff.

5. Now What?

6. Short Run Profit Maximization, Finally…
Profit () = total revenue (tr) – short run total cost (srtc).
(minimum or best) short run total cost
Profit depends on the firm’s output level (q).
That is:  (q) = tr(q) - srtc(q).
Firm’s problem:
choose q* to maximize  where  (q) = tr(q) - srtc(q).
Note something old and something new:
Marginal cost (srmc) = tc/q
Marginal revenue (mr) = tr/q

7. Profit Maximization

8. Rules For Profit ( = TR-TC) Maximization in the Short Run
If q* maximizes (q) = tr(q) – srtc(q) , then
(1) mr(q*) = srmc(q*)
the first order condition, or f.o.c.
(2)  (q*) is a maximum and not a minimum
the second order condition, or s.o.c
(3) at q* it is worth operating
 (q*>0)   (q=0)
NOTE: This procedure is good, no matter what type of firm considered.

9. Intuition: Why mr=mc at the Profit Maximizing q*
Why? Because....
If mr > mc at q, then…
If mr < mc at q, then…
If mr = mc at q, then…

10. “To Be Or Not To Be” Open, The Short Run Shut Down Decision

11. Reality Wrinkle: Sunk & Avoidable Fixed Costs
When q > 0, fixed costs are just that. Fixed.
When q = 0, need to rethink fixed costs
some are sunk fixed costs
some are avoidable fixed costs
How would shut down rule be changed?
i>clicker question: If half of your fixed costs are avoidable fixed costs, then in the short run, would you tend to shut down at a higher or lower market price? A. higher B. lower

12. Short Run Profit Maximization in a Perfectly Competitive Output Market
Consider
Structure, then
Conduct, then
Performance.
Recall Structure for Perfectly Competitive Markets
(1) Many buyers and sellers, and
(2) Homogeneous output, and
(3) Free entry and exit, and
(4) Full and symmetric information.
Our Example
The Apple market, Cortland variety, of which Jonathan’s apple orchard is one of many
Recall:
Structure implies Jonathan is a PRICE TAKER!

13. Conduct: Short Run Profit Maximization in a Perfectly Competitive Output Market
Notation Reminder
q = Jonathan’s output
Q = The aggregate output of the entire apple market
P = The market price for apples
Jonathan is a “price taker”.
So, Jonathan’s perceived demand for HIS apples (δ) will be the prevailing market price P.
So, for Jonathan tr = P∙q
which implies that for Jonathan mr = P = δ
The Market
Jonathan

14. Jonathan’s Profit Maximizing Move When Market Price P=$528
Recall the rules for profit maximizing: If q* maximizes  , then
(1) mr(q*) = srmc(q*)
(2)  (q*) is a maximum and not a minimum.
(3) at q* it is worth operating:  (q*>0)   (q=0)
Jonathan's Apple Farm Costs (detail)
Apples
(tons/year)
$Land
$Hired
Labor
$Proprietor's
time
$Total Cost
$Average
Cost
$Marginal
larger delta method
200
12,400
54,400
13,200
80,000
400
210
58,560
84,160
401
440
220
63,200
88,800
404
484
230
68,240
93,840
408
528
240
73,760
99,360
414
588
250
105,600
422
632
260
86,400
112,000
431

15. Jonathan's Apple Farm Costs (finer detail)
i>clicker question
Suppose P*=$528=mr and you created your $mc column using the small delta method.
If you’re looking at a table of $mc values, and none of them exactly match your $mr value...
you should guess an answer.
you should cry out frantically and loudly.
you should use $mc relative to $mr to narrow down your decision to one of two quantities.
you should try to approximate something between the two quantity values in the table.
then there is no profit maximizing equilibrium quantity.
Jonathan's Apple Farm Costs (finer detail)
Apples (tons/year)
Total Cost
Marginal Cost (smaller delta)
200
80,000
210
84,160
220
88,800
230
93,840
240
99,360
250
105,600
260
112,000