Module 12.1: Breakeven, Shutdown, and Scale (IMprefect Competition)

Via Kaplan & Goodnotes

Define a Firm Price Searcher

• Downward-sloping demand curves

*Note: (MR) Marginal revenue is no longer equal to (P) price

For a Price Searcher Firm, what is true when

TR = TC ?

Break Even

For a Price Searcher Firm, what is true when

TC > TR > TVC?

Firm should

• Continue to operate in the short run

• Shut down in the long run

For a Price Searcher Firm, what is true when

TR < TVC ?

Firm should

• Shut down in the short run AND the long run

Again what is better for analysis when P doesnt equal MR for a firm in imperfect competition?

Analysis based on total costs (TC) and revenues (R) is better suited for examining breakeven and shutdown points.

Describe relations in  Breakeven Point Using the Total Revenue/Total Cost Approach for a price-taker firm

TR increases at a constant rate with quantity

What does this show TC = to?

Total cost = total revenue at the breakeven quantities Q_BE1 and Q_BE2.

Where is economic profit maximized?

Q_max

If in this imperfect competition model, the entire TC curve exceeds TR..how to min loss?

Minimize the economic loss in the short run by operating at the quantity corresponding to the smallest (negative) value of TR – TC.

Example:

For the last fiscal year, Legion Gaming reported total revenue of $700,000, total variable costs of $800,000, and total fixed costs of $400,000.

Should the firm continue to operate in the short run?

• The firm should shut down.

Total revenue of $700,000 is less than total costs of $1,200,000, and it is also less than total variable costs of $800,000.

By shutting down, the firm will lose an amount equal to fixed costs of $400,000.

This is less than the loss of operating, which is TR – TC = $500,000.

If

“That Legion Gaming reported total revenue of $850,000. Total variable costs of $800,000, and total fixed costs of $400,000“

Should the firm continue to operate in the short run? Should it continue to operate in the long run?

• Yes in short run (losses will incurre but TR > TC)

• No in longrun, consider exit bc TR is not sufficient to cover all of the fixed costs and variable costs.

What does each point along the LRATC represent?

The minimum ATC for a given plant size or scale of operations.

What is shown in Economies and Diseconomies of Scale Graph?

Show a firm's LRATC curve along with short-run average total cost (SRATC) curves for many different plant sizes, with SRATC_n+1 representing a larger scale of operations than SRATC_n.

LRATC curve is what shape?

U - Shaped

Average total costs first decreases OR increases with larger scale?

Average total costs first decrease with larger scale

*Eventually begin to increase with larger scale

What is the minimum efficient scale?

The lowest point on the LRATC corresponds to the scale or plant size at which the average total cost of production is at a minimum

Under perfect competition, firms must operate at what capacity? Describe LRATC

Firms must operate at minimum efficient scale in long-run equilibrium, and LRATC will equal the market price

What happens to firms in long-run equilibrium under perfect competition?

In long-run equilibrium:

• Firms earn zero economic profit

• P = ATC at the minimum efficient scale (MES)

If a firm operates at a scale with higher ATC:

• It earns economic losses

• It must either exit the industry or adjust to the minimum efficient scale

The downward-sloping segment of the LRATC curve presented in  Economies and Diseconomies of Scale indicates…

Economies of scale (or increasing returns to scale) are present.

What does economies of scale result from?

Factors such as:

• Labor specialization

• mass production

• investment in more efficient equipment and technology

*In addition, the firm may be able to negotiate lower input prices with suppliers as it increases in size and purchases more resources

A firm operating with economies of scale can increase its competitiveness by doing what? (2)

Expanding production AND reducing costs.

The upward-sloping segment of the LRATC curve indicates…

diseconomies of scale are present

Diseconomies of scale may result from…(3)

• Bureaucracy of larger firms leads to inefficiency

  • Ex. U.S. auto industry

• problems with motivating a larger workforce

• greater barriers to innovation and entrepreneurial activity.

A firm operating under diseconomies of scale will want to..

decrease output and move back toward the minimum efficient scale.

A relatively flat portion at the bottom of the LRATC curve that exhibits

Constant returns to scale or relatively constant costs across a range of plant sizes