Chapter 9:

1. Chapter 9: Short-Run Shut Down and Long-Run Production Concepts

2. Key Topics • SR production • Profits in P, ATC graph • Shut down condition (loss min.) • Firm & industry supply curves • LR production • Isocost lines & LR cost min. (Ch. 6 Appendix) • Returns to scale and LRAC • Equilibrium

3. TFC in AFC graph AFC = TFC/q  TFC = AFC x q $ AFC1 TFC AFC q q1

4. TVC in AVC graph AVC = TVC/q  TVC = AVC x q $ AVC AVC1 TVC q q1

5. TC in ATC graph ATC = TC/q  TC = ATC x q $ ATC ATC1 TC q q1

6. TR in P graph (competitive firm) TR = P x q $ P P TR q q1

7. Revenue-Cost Concepts Profit = TR – TC Operating profit = TR - TVC

8. Profit in P, ATC Graph • See Fig. 9.1.

9. SR Profit If shut down π = TR – TVC – TFC = 0 – 0 – TFC = - TFC

10. SR Profit If produce π = TR – TVC – TFC • Produce if produce π > shut down π (loss)  TR – TVC – TFC > -TFC  TR – TVC > 0 (operating π > 0  TR > TVC  pq > AVC (q)  p > AVC ( firm S curve = MC curve above AVC)  shut down if P < AVC

11. SR Profit Scenarios • Produce, π > 0 • Produce, π < 0 (loss less than – TFC) • Don’t produce, π = -TFC

12. SR vs LR Production if q = f(K,L) SR: K is fixed  only decision is q which determines L LR: K is NOT fixed  decisions = 1) q and 2) what combination of K & L to use to produce q Recall, π = TR – TC  to max π of producing given q, need to min. TC

13. Budget Line = maximum combinations of 2 goods that can be bought given one’s income = combinations of 2 goods whose cost equals one’s income

14. Isocost Line = maximum combinations of 2 inputs that can be purchased given a production ‘budget’ (cost level) = combinations of 2 inputs that are equal in cost

15. Isocost Line Equation TC1 = rK + wL • rK = TC1 – wL • K = TC1/r – w/r L Note: ¯slope = ‘inverse’ input price ratio = ΔK / ΔL = rate at which capital can be exchanged for 1 unit of labor, while holding costs constant

16. Isocost Line (specific example) TC1 = 10,000 r = 100  max K = 10,000/100 = 100 w = 10  max L = 10,000/10 = 1000 K 100 TC1 = 10,000  K = 100 - .1L L 1000

17. Equation of TC1 = 10,000 (r = 100, w = 10)

18. Increasing Isocost K TC3 > TC2 > TC1 L TC1 TC2 TC3

19. Changing Input Prices K TC1 TC1 r w L L

20. Different Ways (costs) of Producing q1 K 1 2 q1 3 TC3 TC2 TC1 L

21. Cost Min Way of Producing q1 K K* & L* are cost-min. combinations Min cost of producing q1 = TC1 1 K* 2 q1 3 TC3 TC2 TC1 L L*

22. Cost Minimization - Slope of isoquant = - slope of isocost line

23. Average Cost and Output • SR Avg cost will eventually increase due to law of diminish MP ( MC will start to  and eventually pull avg cost up) • LR economics of scale a) If increasing  LR AC will  with  q b) If constant  LR AC does not change with  q c) If decreasing  LR AC will  if  q

24. LR Equilibrium  P of output = min LR AC LR Disequilibrium • P > min LR AC (from profits) • Firms will enter •  mkt S   P • P < min LR AC (firm losses) • Firms will exit •  mkt S   P