1. Short Run versus Long Run Short Run  Firms must meet their short run commitments  Terminology: When a firm goes out of business in the short run, we say that the firm shuts down. Long Run  Firms can escape their short run commitments  Terminology: When a firm goes out of business in the long run we say that the firm exits the industry. Short Run Shutdown “Rule” Price and Average Variable Cost (AVC)  P < AVC  Firm goes out of business in the short run  The firm shuts down. Long Run Exit “Rule” Price and Average Total Cost (ATC)  P < ATC  Firm goes out of business in the long run  The firm exits the industry. Long Run Supply

2. Review: Jeff Lord and His Consulting Firm He departed from Anderson on very good terms; he was told that he could return at his $25,000 per month salary. On January 1, 2015, Jeff Lord resigned from Arthur Anderson. where he worked as a business consultant earning $25,000 a month, to start his own consulting firm. He signed a one-year lease for office space requiring Jeff to pay his landlord $20,000 per month in rent until January 1, 2016. He hired several employees whose wages summed to $35,000 a month. Opportunity Costs $25,000 Accounting Costs $55,000 Total Costs (TC) $80,000 Rent $20,000 Employee Wages $35,000 Anderson Salary $25,000 The Short Run versus the Long Run Short Run  Firms must meet their short run commitments Long Run  Firms can escape their short run commitments Question: What date separates the short run from the long run in Jeff’s case? Answer: January 1, 2016

3. Jeff’s income when operates his firm Price: $650/hourQuantity: 100 hours per month Total Revenue: P  q = $65,000 per month Jeff’s monthly income when operating his firm = $65,000  $55,000 = $10,000 Total Revenues Acc’ting Costs = $650  100 Anderson Salary $25,000 Accounting Costs $55,000 Total Costs (TC) $80,000 Rent $20,000 Employee Wages $35,000 Opportunity Costs $25,000 Jeff’s monthly income in the long run if he goes out of business on January 1, 2016 = $25,000 Opportunity Costs Question: On January 1, 2016 will Jeff continue to operate his firm or will he go out of business and return to Anderson? To answer this question we will compare Jeff’s income if he returns to Anderson Generalizing Jeff’s monthly income when operating his firm Jeff’s monthly income in the long run if he goes out of business on January 1, 2016  = = Answer: Jeff will go out of business and return to Anderson.

4. Jeff’s monthly income if he continues to operate his firm = Total Revenue Jeff’s monthly income in the long run if he goes out of business Opportunity Costs  Accounting Costs = Opportunity Costs $25,000 Accounting Costs $55,000 Total Costs (TC) $80,000 Rent $20,000 Employee Wages $35,000 Anderson Salary $25,000 Profit of Jeff’s FirmTotal Revenue  Total Costs= Total Revenue  (Accounting Costs + Opportunity Costs)= Total Revenue  Accounting Costs  Opportunity Costs = (Total Revenue  Accounting Costs)  Opportunity Costs =  Jeff’s monthly income if he continues to operate his firm  Jeff’s monthly income in the long run if he goes out of business  Claim: Since (the economist’s) total cost includes opportunity costs, profit compares the income Jeff would earn if he operates his firm if the income if he would earn in the long run if he goes out of business. =Profit of Jeff’s Firm

5. Total Revenue  Total Cost= PqPq   ATC  q = Total Revenue = P  q ATC = Total Cost Total Cost = ATC  q q = (P  ATC)  q Profit of Jeff’s Firm= Jeff’s monthly income if he continues to operate his firm Jeff’s monthly income in the long run if he goes out of business  P<ATC  Jeff’sJeff’s incomeincome when < in the long run operatingif he goes his firmout of business  Jeff earns less income by operating his firm than by working for someone else.  Exit occurs in the long run P>ATC  Jeff’sJeff’s incomeincome when > in the long run operatingif he goes his firmout of business  Jeff earns more income by operating his firm than by working for someone else.  Entry occurs in the long run P=ATC  Jeff’sJeff’s incomeincome when = in the long run operatingif he goes his firmout of business  Jeff earns the same income by operating his firm or by working for someone else.  Long run equilibrium  Profit<0  Profit=0  Profit>0 Claim: A firm’s profit depends on price P and average total cost (ATC).

6. q MC ATC Claim: The ATC curve intersects the MC curve at minimum ATC. The MC curve is upward sloping. MC < ATC ATC falls MC > ATC ATC rises Justification: Suppose that the average weight of us in the classroom equals 150 pounds. Then, one more person walks into the room. How will the additional person affect our average weight? Consider two scenarios: Additional person weighs 30 pounds  Weight of additional person is less than the average.  The average falls Additional person weighs 330 pounds  Weight of additional person is greater than the average.  The average rises Marginal less than average  The average falls Marginal greater than average  The average rises Marginal Weight: Change in the total weight of us in the classroom resulting from a one person change in the classroom size. Question: What does the ATC curve look like?

7. q MC ATC Claim: The ATC curve intersects the MC curve at minimum ATC. q MC ATC q MC ATC Intersection to the right of min ATC Intersection to the left of min ATC MC < ATC Can ATC be rising? MC > ATC Can ATC be falling? The MC curve is upward sloping. MC < ATC ATC falls MC > ATC ATC rises

8. MC q D S Q P P* q* MR = P* Putting the Pieces Together: The Market Equilibrium and the Typical Firm MarketTypical Firm Market Demand Curve Market Supply Curve Horizontal sum of each individual firms supply curve Equilibrium Price Quantity demanded Quantity supplied equals Individual Firm’s Supply Curve The firm’s marginal cost (MC) curve, as long as price exceeds average variable cost. Marginal revenue (MR) Marginal cost (MC) equals Perfectly Competitive Industry Large number of small, independent firms. MR equals PriceAverage Total Cost (ATC) Curve Three Scenarios:P* < Min ATCP* > Min ATCP* = Min ATC

9. ATC MC qQ P Scenario 1: P* < Min ATC P* q*  Max profit: q = q*  P* < ATC  Profit < 0  Firms exit in the long run  Supply curve shifts left in the long run  Price rises in the long run D S MR = P* S’ Summary P* < Min ATC  Price rises in the long run Intersects the marginal cost curve (MC) at minimum average total cost. Average Total Cost (ATC) Curve

10. ATC MC qQ P Scenario 2: P* > Min ATC P* q*  Max profit: q = q*  P* > ATC  Profit > 0  Firms enter in the long run  Supply curve shifts right in the long run  Price falls in the long run D S MR = P* S’ Intersects the marginal cost curve (MC) at minimum average total cost. Summary: P* > Min ATC  Price falls in the long run Average Total Cost (ATC) Curve

11. ATC MC q D S Q P Scenario 3: P* = Min ATC P* q*  Max profit: q = q*  P* = ATC  Profit = 0  Long run equilibrium  Supply curve will not shift in the long run MR = P* Summary: P* = Min ATC  Long run equilibrium Intersects the marginal cost curve (MC) at minimum average total cost. Average Total Cost (ATC) Curve  Price does not change in the long run

12. Summary Profit, Price, Average Total Cost, Exit, Entry, and Long Run Equilibrium P*<Min ATC  When profit is maximized P* < ATC  Exit occurs in the long run  Market supply curve shifts to the left in the long run P*>Min ATC  When profit is maximized P* > ATC  Entry occurs in the long run  Market supply curve shifts to the right in the long run P*=Min ATC  When profit is maximized P* = ATC  Long run equilibrium  Profit < 0  Profit > 0  Profit = 0  Price rises in the long run  Price falls in the long run