ECON 3 Chapter 8 Part 2

Flashcards based on ECON 003 Lecture Notes - Chapter 8

If P < ATC, should a firm always shut down immediately?

Not necessarily. If shutting down reduces variable costs to zero but fixed costs remain, the firm may still incur losses if it must continue paying fixed costs.

What is the condition for a firm to shut down in Scenario 1?

P < min(AVC). The firm cannot pay all of its variable costs even if it pays none of its fixed costs.

What is the condition for a firm to continue operating in Scenario 2?

P > min(AVC). The firm can pay all of its variable costs and has some revenue left over to pay some of its fixed costs.

What is the shutdown point?

The price below which the firm will lack enough revenue to cover its variable costs, and will thus shutdown, and it's found at the price at which the MC curve and the AVC curve intersect, and at the price at which AVC is at minimum

What is the simple version of the shutdown rule?

If P < minimum AVC, the firm shuts down. If P > minimum AVC, the firm continues operating.

Why is the firm's supply curve the MC curve at points at or above the minimum point of the AVC curve?

A firm checks the market price and then looks at its MC to determine the quantity to produce (P = MC), but before producing that quantity, the firm makes sure that P > AVC. If P < AVC, then the firm will produce zero quantity!

What is entry in the context of firms?

When new firms enter an industry in response to industry profits.

What is exit in the context of firms?

When existing firms reduce production and/or shut down in response to industry losses.

What conditions define long-run equilibrium for firms?

Firms earn zero economic profits by producing at the output level where P = MR = MC and P = ATC, and no firm has an incentive to enter or leave the market.

What is the formula for profit?

Profit = (price – ATC) * Q

What happens if demand for a product increases, leading to short-run profits?

New firms will be attracted by profits, the market supply curve shifts to the right, the market price decreases until economic profits are zero, which leads to long-run equilibrium.

What happens if demand for a product decreases, leading to short-run losses?

Firms where P < firm’s AVC will shut down, the market supply curve shifts to the left, the market price increases until economic profits are zero, which leads to long-run equilibrium.

What is the zero-profit point?

The point where Total Revenue = Total Costs

What is the impact of entry and exit on prices and average total costs?

Entry and exit of firms pushes price to minimum average total costs, causing all firms to earn zero profit in the long run.

What are the three types of industries based on long-run adjustment?

Constant-cost, Increasing cost, and Decreasing cost industries.

What characterizes a constant-cost industry?

As demand for products increases, the cost of production for firms stays the same due to constant returns to scale.

What characterizes an increasing cost industry?

As demand for product increases, the cost of production for firms increases due to diseconomies of scale.

What characterizes a decreasing cost industry?

As demand for product increases, the cost of production for firms decreases due to economies of scale.

What is productive efficiency?

Given the available inputs and technology, it is impossible to produce more of one good without decreasing the quantity that is produced of another good.

What is allocative efficiency?

The particular combination of goods and services on the productive possibilities curve that society most desires.

How does perfect competition lead to productive efficiency?

Price in the market is equal to the minimum of the LRAC curve in the long run.

How does perfect competition lead to allocative efficiency?

Price will be equal to the marginal cost of production, meaning benefits from producing the good equal the costs of producing the good.

In a perfectly competitive market, what condition ensures allocative efficiency?

P = MC (Price equals Marginal Cost).

Which market structures DO NOT produce productive efficiency or allocative efficiency?

Oligopoly, Monopolistic competition, and Monopoly, because P > MC in these structures