If a firm operating in a competitive industry shuts down in the short run, it can avoid paying

1. Because a competitive firm is a price taker, its revenue is proportional to the amount of output it produces. The price of the good equals both the firm’s average revenue and its marginal revenue.
2. To maximize profit, a firm chooses a quantity of output such that marginal revenue equals marginal cost. Because marginal revenue for a competitive firm equals the market price, the firm chooses quantity so that price equals marginal cost. Thus, the firm’s marginal cost curve is its supply curve.
3. In the short run, when a firm cannot recover its fixed costs, the firm will choose to shut down temporarily if the price of the good is less than average variable cost. In the long run, when the firm can recover both fixed and variable costs, it will choose to exit if the price is less than average total cost.
4. In a market with free entry and exit, profits are driven to zero in the long run. In this long-run equilibrium, all firms produce at the efficient scale, price equals minimum average total cost, and the number of firms adjusts to satisfy the quantity demanded at this price.
5. Changes in demand have different effects over different time horizons. In the short run, an increase in demand raises prices and leads to profits, and a decrease in demand lowers prices and leads to losses. But if firms can freely enter and exit the market, then in the long run the number of firms adjusts to drive the market back to the zero-profit equilibrium.

I. What Is a Competitive Market?

A. The Meaning of Competition

B. The Revenue of a Competitive Firm

1. Total revenue from the sale of output is equal to price times quantity.

1. Definition of Marginal Revenue: the change in total revenue from an additional unit sold.

3. The profit-maximizing quantity can also be found by comparing marginal revenue and marginal cost.

a. As long as marginal revenue exceeds marginal cost, increasing output will raise profit.

1. If marginal revenue is less than marginal cost, the firm can increase profit by decreasing output.
2. Profit-maximization occurs where marginal revenue is equal to marginal cost.

a. If marginal revenue is greater than the marginal cost, the firm can increase its profit by increasing output.

b. If marginal cost is greater than marginal revenue, the firm can increase its profit by decreasing output.

c. At the profit-maximizing level of output, marginal revenue is equal to marginal cost.

1. In some circumstances, a firm will decide to shut down and produce zero output.

2. There is a difference between a temporary shutdown of a firm and an exit from the market.

a. A shutdown refers to the short-run decision not to produce anything during a specified period of time because of current market conditions.

b. Exit refers to a long-run decision to leave the market.

c. One important difference is that, when a firm shuts down temporarily, it still must pay fixed costs.

3. If a firm shuts down, it will earn no revenue and will have only fixed costs (no variable costs).

4. Therefore, a firm will shut down if the revenue that it would get from producing is less than its variable costs of production:

Shut down if TR < VC

.

5. Since TR = P * Q and VC = AVC * Q, we can rewrite this condition as:

Shut down if P < AVC

. (Below the Shutdown Point)

D. The Firm’s Long-Run Decision to Exit or Enter a Market

1. If a firm exits the market, it will earn no revenue, but it will have no costs as well.

2. Therefore, a firm will exit if the revenue that it would earn from producing is less than its total costs:

Exit if TR < TC

.

3. Since TR = P * Q and TC = ATC * Q, we can rewrite this condition as:

Exit if P < ATC

. (Below 0-Profit Point)

4. A firm will enter an industry when there is profit potential, so this must mean that a firm will enter if revenues will exceed costs:

Enter if P > ATC

.

1. A monopoly is a firm that is the sole seller in its market. A monopoly arises when a single firm owns a key resource, when the government gives a firm the exclusive right to produce a good, or when a single firm can supply the entire market at a lower cost than many firms could.
2. Because a monopoly is the sole producer in its market, it faces a downward-sloping demand curve for its product. When a monopoly increases production by one unit, it causes the price of its good to fall, which reduces the amount of revenue earned on all units produced. As a result, a monopoly’s marginal revenue is always below the price of its good.
3. Like a competitive firm, a monopoly firm maximizes profit by producing the quantity at which marginal revenue equals marginal cost. The monopoly then chooses the price at which that quantity is demanded. Unlike a competitive firm, a monopoly firm’s price exceeds its marginal revenue, so its price exceeds marginal cost.
4. A monopolist’s profit-maximizing level of output is below the level that maximizes the sum of consumer and producer surplus. That is, when the monopoly charges a price above marginal cost, some consumers who value the good more than its cost of production do not buy it. As a result, monopoly causes deadweight losses similar to the deadweight losses caused by taxes.
5. Policymakers can respond to the inefficiency of monopoly behavior in four ways. They can use the antitrust laws to try to make the industry more competitive. They can regulate the prices that the monopoly charges. They can turn the monopolist into a government-run enterprise. Or, if the market failure is deemed small compared to the inevitable imperfections of policies, they can do nothing at all.
6. Monopolists often can raise their profits by charging different prices for the same good based on the buyer’s willingness to pay. This practice of price discrimination can raise economic welfare by getting the good to some consumers who otherwise would not buy it. In the extreme case of perfect price discrimination, the deadweight losses of monopoly are completely eliminated. More generally, when price discrimination is imperfect, it can either raise or lower welfare compared to the outcome with a single monopoly price.

Be sure you know what a monopoly is and why they can remain a monopoly. What are the barriers to entry and what are some real-world examples? What is a natural monopoly? Be able to compare the monopoly situation to perfect competition: price, demand, marginal cost, marginal revenue, welfare, and etc. How should we regulate monopolies? Know the graphs!

When a competitive firm will shut down in the short run?

What does a firm that shuts down temporarily still have to pay?

When should a firm shut down in perfect competition in short run?

When a perfectly competitive firm makes a decision to shut down it is most likely that?