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

Via Kaplan + GoodNotes Graphs

Define Short Run

In context of a firm, is the period in which factors of production are fixed

What is an example of factors of production being fixed in the Short Run?

Examples:

• A fixed lease for duration of 5 years…is fixed and firm unable to change the size of the building

• Equipment purchased thats expensive…firm cant sell or adjust its major equipment

Define the Long Run

In context of a firm, is the period in which factors of production are ALL variable

Example: The firm can let its leases expire and sell its equipment, thereby avoiding costs that are fixed in the short run.

When does a firm break even?

A firm breaks even when:

Total Revenue = Total Cost

If TR = TC, what is also true?

TR = TC

Since
P = AR and ATC = TC / Q,

(Price = Average Revenue = Average Total Cost = Total Cost/Quantity)

At breakeven:
P = AR = ATC

Economic Profit = 0

What is true about a firm if..

“Items are being sold for more than their variable cost..“

The store should continue to operate to minimize losses

What is true about a firm if..

“Items are being sold for less than their average variable cost…”

Losses would be reduced by shutting down the business in the short run.

When should a business shut down in Long run?

P < ATC

Price < Average Total Cost

*Regardless of the relation between price and average variable cost (AVC)

What is a firm that is a Price Taker

A price-taking firm is a firm that cannot influence the market price and must accept the price determined by overall market supply and demand.

Describe the relationship with point A_…

At P1:

Price and average revenue equal average total cost.

P = AR = ATC

A: At the output level of Point A, the firm is making an economic profit of zero.

Define where economic profit is on the following:

Economic Profit: Price ABOVE P1, economic profit is positive

NOT Economic Profit: Prices less than P₁, economic profit is negative

*AKA firm has economic losses.

When should a firm continue producing in the short run?

A firm should continue producing in the short run as long as:

AR ≥ AVC

Average Revenue ≥ Average Variable Cost

Because fixed costs must be paid anyway, the firm only needs to cover variable costs to keep operating.

If AR < AVC, the firm should shut down.

What is treu about the firm & their production between P1 & P2?

• Firm has losses

• The losses are smaller than would occur if all production were stopped

As long as

TR > TVC , at least some of the firm's fixed costs are covered by continuing to produce and sell its product

What would occur if the firm were to shutdown?

Losses = fixed costs that still must be paid

How does the firm minimize its losses in the short run by continuing in business?

Price > AVC

What is true if

AR < AVC ?

• Firm losses are GREATER than fixed costs

• Minimize losses by shutting down production in short run

*Shown in less than P2

(the loss from continuing to operate is greater than the loss (total fixed costs) if the firm is shut down)

What is true if in the long-run if all costs are variable?

A firm can avoid its (short-run) fixed costs by shutting down

• For this reason, if price is expected to remain below minimum average total cost (Point A in  Shutdown and Breakeven) in the long run, the firm will shut down rather than continue to generate losses.

Define Short-run shutdown point

Average revenue is less than average variable cost

AR < AVC

= short run, the firm should shut down

Define Long-run shutdown point

AR < ATC

Shut down if average revenue is less than average total cost

What is true if If average revenue is greater than average variable cost in the short run…

(AR > AVC)

the firm should continue to operate, even if it has losses

Define Breakeven point

If average revenue is just equal to average total cost, total revenue is just equal to total (economic) cost

AR = ATC

TR = TC

If AR ≥ ATC,

the firm should stay in the market in both the short and long run.

If AR ≥ AVC, but AR < ATC

the firm should stay in the market in the short run but will exit the market in the long run.

If AR < AVC

the firm should shut down in the short run and exit the market in the long run.