Short Run Decisions in Perfect Competition

REMEMBER:
-Demand in perfect competition is constant for individual firms (it does not change with quantity produced), and demand is equal to price, average revenue, and marginal revenue.
-Supply is equal to the marginal cost curve above the average variable cost curve.

We're going to look at some different scenarios for firms in perfect competition in the short run. For each of these, we try to calculate economic profit. Here's how:

-First, we find out which quantity will allow Marginal Revenues is equal to Marginal Costs
-Next we calculate total revenue, which is the price X the quantity exchanged
-Next we calculate the total cost, which is the average cost for this quantity X the quantity exchanged
-Finally we determine economic profit by subtracting the total costs from the total revenue. The remaining money is economic profit!

SCENARIO ONE: ECONOMIC PROFIT

Here, marginal revenue = marginal costs at a point where the average revenue (price) is greater than the average costs. Because of this, revenue will exceed costs, thus creating positive economic profit in the short run. NOTE: This usually signals firms to enter the industry, which occurs over the long run.

SCENARIO TWO: NORMAL PROFIT

Here, marginal revenue = marginal costs at a point where the average revenue (price) is just equal to average costs. Because of this, revenue will equal costs, thus creating zero economic profit (aka: normal profit). In a normal profit scenario, firms are making the same amount of accounting profits in this industry that they would anywhere else. There is no incentive for firms to enter or leave the industry.

SCENARIO THREE: ECONOMIC LOSS

Here. marginal revenue = marginal costs at a point where the average revenue (price) is lower than average costs. As a result, firms in this scenario will take an economic loss on production (they could still be making accounting profits on their business, but that money would make more profits if invested elsewhere). In the long run, economic losses act as a signal for firms to leave a business. However, firms which are operating at an economic loss should not necessarily exit the industry. As long as they continue to cover daily operating costs, they are 'breaking even' in an accounting sense, and should continue to produce.

SCENARIO FOUR: SHUT DOWN POINT

Here, total revenue is much lower than total costs (negative economic profit). Average revenue JUST equal average variable costs, which means that this firm can JUST cover daily expenses (zero accounting profit). Any point below this, and the firm will be operating at a loss, and should shut down.

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SHORT RUN SUPPLY CURVES:
-a supply curve shows a firm's willingness to produce at any given price.

remember:
-a demand curve is derived using the principles of total utility maximization, so when price increases, quantity demanded decreases
-a supply curve is derived using the principles of profit maximization, so when the price increases, quantity supplied increases.

THE MARGINAL COST ABOVE THE AVERAGE VARIABLE COST CURVE IS THE SHORT RUN SUPPLY CURVE FOR FIRMS IN PERFECT COMPETITION! As the price increases, marginal costs will = marginal revenue at a greater quantity of production.


INDUSTRY SUPPLY IN THE SHORT RUN FOR PERFECT COMPETITION
Industry supply for the short run is just the horizontal sum of each individual firm's supply curves (aka their marginal cost curve above average variable cost)
-It is the short run, because the cost curves are holding capital constant (so individual firms cannot change their scale of production)

CONDITIONS FOR SHORT RUN INDUSTRY EQUILIBRIUM:
1-The demand and supply must be equal for the industry
2-Each firms must be maximizing profits (minimizing losses)
3-This does not necessarily mean that all of the firms will be making economic profit. If there are too many firms in the industry, in the short run, all of the firms may be making economic losses while operating at maximum profit

THATS ALL FOR NOW