and Unit 3 – Theory of the FirmPart 2

1. Many buyers and sellers 2. All the products are homogeneous. 3. All buyers & sellers are price takers. 4. There are NO barriers to entry. 5. There is perfect information. 6. Firms cannot earn economic profits in the long run. In the previous lecture we learned about the economic model of ….. 2 of 9

P Q cost quantity S D Q P p What does each of these abbreviations stand for? MR=D=AR=P Briefly, why is each equal to the other? firm industry How do we label the demand curve for the individual firm?

P Q cost quantity S D Q P p MC q How does this relate to “making decisions on the margin?” MR=D=AR=P firm industry How does the individual firm determine where it will produce? A firm maximizes profits where MC = MR

P Q cost quantity S D Q P p MC q when resources are distributed in a way to maximize utility; here the cost of the next one is equal to the price (value) of the next one (P = MC); both the firm and the consumer are getting the max that they can MR=D=AR=P firm industry Where MC = MR is the point of allocative or economic efficiency for our economy. 5 of 9

Where will this firm produce? P Q quantity S D Q p ATC MC MR=D=AR=P market P cost firm AVC q Is this firm making an economic profit? MC = MR No Should this firm shut down?No Why not? B/c at point q it is covering all of its AVC and some of its sunk costs (AFC) AVC covered some AFC covered

Price must fall to what level for the firm to shutdown? P Q quantity S D Q p ATC MC MR=D=AR=P market P cost firm AVC p2p2 shutdown point where MC = MR = AVC

P Q cost quantity S D Q p ATC MC q MR=D=AR=P market firm P Is the above firm making a profit? It is making a normal profit b/c a normal profit is figured into the cost of doing business; but it is not making an economic profit; it is at equilibrium output & price AVC

P Q cost quantity S D Q p ATC MC q MR=D=AR=P market firm P The above firm is producing at productive (or technical) efficiency….. where it is operating at its minimum ATC AVC explain why here it is producing goods for society at the very lowest cost of resources for society 9 of 9