ECON 1 Lecture Notes - Lecture 12: Sunk Costs, Opportunity Cost, Deadweight Loss
29 May 2018
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ECON 1: Chapter 14 Notes
Focus Questions:
• What is a perfectly competitive market?
• What is marginal revenue? How is it related to total and average revenue?
• How does a competitive firm determine the quantity that maximizes profits?
• When might a competitive firm shut down in the short run? Exit the market in the long run?
• What does the market supply curve look like in the short run? In the long run?
Characteristics of Perfect Competition
1. Many buyers and many sellers.
2. The goods offered for sale are largely the same.
3. Firms can freely enter or exit the market.
▪ Because of 1 & 2, each buyer and seller is a “price taker” – takes the price as given.
The Revenue of a Competitive Firm
MR = P for a Competitive Firm
Profit Maximization
▪ What Q maximizes the firm’s profit?
▪ To find the answer, “think at the margin.”
If increase Q by one unit, revenue rises by MR, cost rises by MC.
▪ If MR > MC, then increase Q to raise profit.
▪ If MR < MC, then reduce Q to raise profit.
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MC and the Firm’s Supply Decision
Shutdown vs. Exit
▪ Shutdown:
A short-run decision not to produce anything because of market conditions.
▪ Exit:
A long-run decision to leave the market.
▪ A key difference:
▪ If shut down in SR, must still pay FC.
▪ If exit in LR, zero costs.
A Firm’s Short-run Decision to Shut Down
A Competitive Firm’s SR Supply Curve
find more resources at oneclass.com
find more resources at oneclass.com
Document Summary
The goods offered for sale are largely the same. Firms can freely enter or exit the market: because of 1 & 2, each buyer and seller is a price taker takes the price as given. Profit maximization: what q maximizes the firm"s profit, to find the answer, think at the margin. If increase q by one unit, revenue rises by mr, cost rises by mc. If mr > mc, then increase q to raise profit. If mr < mc, then reduce q to raise profit. A short-run decision not to produce anything because of market conditions: exit: A long-run decision to leave the market: a key difference: If shut down in sr, must still pay fc. The irrelevance of sunk costs: sunk cost: a cost that has already been committed and cannot be recovered, sunk costs should be irrelevant to decisions; you must pay them regardless of your choice.
