Ch-9 - Ist Sem 23-24

Chapter
9
Long-Run Costs
and Output Decisions
Prepared by:
Fernando & Yvonn Quijano
© 2007 Prentice Hall Business Publishing Principles of Economics 8e by Case and Fair
Long-Run Costs
9
CHAPTER 9: Long-Run Costs and
Chapter Outline
Output Decisions
Short-Run Conditions and Long-

Run Directions
Maximizing Profits
Minimizing Losses
The Short-Run Industry Supply Curve
Long-Run Directions: A Review
Long-Run Costs: Economies and
Diseconomies of Scale
Increasing Returns to Scale
Constant Returns to Scale
Decreasing Returns to Scale
Long-Run Adjustments
to Short-Run Conditions
Short-Run Profits: Expansion to Equilibrium
Short-Run Losses: Contraction to Equilibrium
The Long-Run Adjustment Mechanism:
Investment Flows toward Profit Opportunities
Output Markets: A Final Word
Appendix: External Economies and
Diseconomies and the Long-Run Industry
Supply Curve
© 2007 Prentice Hall Business Publishing Principles of Economics 8e by Case and Fair 2 of 36
Introduction: Price & Cost determines Profit
▪ Firms use information on input prices, output prices, and technology

to make the decisions that will lead to the most profit.
▪ Because profits equal revenues minus costs, firms must know
how much their products will sell for and how much production
Output Decisions
will cost, using the most efficient technology.

▪ Once a firm has a clear picture of its short-run costs, the price at
which it sells its output determines the quantity of output that will
maximize profit.
For Profit (MR=MC)

▪ Specifically, a profit-maximizing perfectly competitive firm will supply
output up to the point that price (marginal revenue) equals
marginal cost.
▪ The marginal cost curve of such a firm is thus the same as its
supply curve.
SS Decisions in Long Run vs Short Run
▪The condition in which firms find Example: Decisions made by the Manager
themselves in the short run (Are of a firm (Short vs Long Run)
they making profits? Are they
incurring losses?) determines what Short-run decisions:
is likely to happen in the long run.
▪You are stuck with a particular factory and set

Output Decisions
of machines, and your decisions involve asking

▪Remember that output (supply) how best to use those assets to produce
decisions in the long run are less output.
constrained than in the short run,
for two reasons. Strategic long-run thinking:
▪First, in the long run, the firm ▪Should you be in this business at all, or should
can increase any or all of its you close up shop?
inputs and thus has no fixed ▪In better times, you might consider expanding
factor of production that the operation.
confines its production to a
given scale. ▪In thinking about the long run, you will also
have to reckon with other firms entering and
▪Second, firms are free to enter
industries to seek profits and to exiting the industry
leave industries to avoid losses
Managers simultaneously make short- and
long-run decisions, making the best of the
current constraints while planning for the future
Long-run Cost Curve:
Long-run cost curves need not slope up at all
▪ In making decisions or ▪ Under these circumstances, it is
understanding industry structure, no longer inevitable that
the shape of the long-run cost increased volume comes with
curve is important. higher costs.
▪ Long-run cost curves need

Output Decisions
▪ As we saw in the short run, a fixed not slope up at all.

factor of production eventually
causes marginal cost to increase ▪ Different types of Long Run
along with output. cost curve:
▪ In the long run, all factors can ▪ You might have wondered
be varied. why there are only a few
automobile and steel
companies in the India but
▪ In the earlier sandwich shop example, dozens of firms producing
in the long run, we can add floor books and furniture.
space and grills along with more ▪ Differences in the shapes of
people to make the sandwiches. the long-run cost curves in
those industries do a good job
of explaining these
differences in the industry
structures.
Firms in three short-run circumstances:
We begin our discussion of the long run by looking at firms in three
short-run circumstances:
(1) firms earning economic profits,

Output Decisions
(2) firms suffering economic losses but continuing to operate to

reduce or minimize those losses, and
(3) firms that decide to shut down and bear losses just equal to
fixed costs.
Normal rate of return & Breaking even
▪ A normal rate of return is a rate that is just sufficient to keep

current investors interested in the industry.
▪ Because we define profit as total revenue minus total cost
and because total cost includes a normal rate of return, our

Output Decisions
concept of profit takes into account the opportunity cost of

capital.
▪ Earning greater than Normal rate of return

▪ When a firm is earning an above-normal rate of return, it
has a positive profit level; otherwise, it does not.
▪ Earning exactly Normal rate of return

▪ A firm that is breaking even, or earning a zero level of
profit, is one that is earning exactly a normal rate of return.
▪ New investors are not attracted, but current ones are
not running away either.
Three conditions for a firm
▪ With these distinctions in mind, we can say that for any firm,
one of three conditions holds at any given moment:
▪ (1) The firm is making positive profits,
▪ (2) the firm is suffering losses, or

Output Decisions
▪ (3) the firm is just breaking even.
breaking even The situation in which a firm is earning exactly a

normal rate of return.
Profitable firms will want to maximize their profits in the short

run, while firms suffering losses will want to minimize those
losses in the short run.
Maximizing Profits Example: The Blue Velvet Car Wash
Car washes require a facility. Total Fixed Cost
Normal rate of return The car wash is currently servicing 800
▪ In the case of Blue Velvet, suppose cars a week and can be open 50 weeks a
investors have put up $500,000 to year (2 weeks for maintenance).
construct a building and purchase all ▪ The cost of the basic maintenance
Output Decisions
the equipment required to wash contract on the equipment is $50,000 per

cars. year, and Blue Velvet has a contract to
▪ If the car wash closes, the building pay for those services for a year whether
and equipment can be sold for its it opens the car wash or not.
original purchase price, but as long ▪ The fixed costs then for the car wash
as the firm is in business, that are $100,000 per year: $50,000 for the
capital is tied up. capital costs and $50,000 for the
equipment contract.
▪ If the investors could get 10 percent ▪ On a weekly basis, these costs amount
return on their investment in another to $2,000 per week.
business, then for them to keep their ▪ If the car wash operates at the level of
money in this business, they will also 800 cars per week, fixed costs are $2.50
expect 10 percent from Blue Velvet. per car ($2,000/800).
▪ Thus, the annual cost of the
capital needed for the TFC/Week = $2000/week
business is $50,000 (10
percent of $500,000) TFC/Car = $2.5/car
Total Variable Cost: Total Revenue:
There are also variable costs ▪ This car wash business is quite
associated with the business. competitive, and the market price for
▪ To run a car wash, one needs this service at the moment we are
workers and soap and water. considering is $5.
Output Decisions
▪ Workers can be hired by the hour for

$10.00 an hour, and at a customer TR/Week = $4000/week
level of 800 cars per week, each TR/Car = $5/car
worker can wash 8 cars an hour.
▪ At this service level, then, Blue Profit/Loss:
Velvet hires workers for 100 hours
▪ At a service level of 800 cars, as you
and has a wage bill of $1,000.
see from the table, Blue Velvet is
▪ The labor cost of each car wash, making a positive profit of $400 per
when Blue Velvet serves 800 week.
customers, is $1.25 ($10/8). ▪ For each car washed, it receives
▪ Every car that is washed costs $0.75 $5 and spends $4.50 ($2.50 in
in soap, adding $600 to the weekly fixed costs + $1.25 in labor costs
bill if 800 car washes are done. + $0.75 in soap), for an excess
profit of $0.50 per car.
TVC/Week = $1600/week
TVC/Car = $2/car Profit/Week = $400/week
Profit/Car = $0.5/car
Blue Velvet Car Wash Weekly Costs
Table 9.1 summarizes the costs of Blue Velvet at the 800 washes per week level
TABLE 9.1 Blue Velvet Car Wash Weekly Costs

Output Decisions
TOTAL VARIABLE COSTS TOTAL COSTS

TOTAL FIXED COSTS (TFC) (TVC) (800 WASHES) (TC = TFC + TVC) $ 3,600
1. Normal return to investors $ 1,000 1. Labor $ 1,000 Total revenue (TR)

2. Materials 600 at P = $5 (800 x $5) $ 4,000
2. Other fixed costs $ 1,600 Profit (TR - TC) $ 400

(maintenance contract,
insurance, etc.) 1,000
$ 2,000
Firm Earning Positive Profits in the Short Run
Graphic Presentation
Output Decisions
FIGURE 9.1 Firm Earning Positive Profits in the Short Run
Firm Earning Positive Profits in the Short Run: Profit
▪ A profit-maximizing perfectly competitive firm will produce up to the

point where P* = MC.
▪ Profit is the difference between total revenue and total cost (at q* = 800)
▪ total revenue is $5 * 800 = $4,000,

Output Decisions
▪ total cost is $4.50 * 800 = $3,600, and

▪ profit = $4,000 - $3,600 = $400.
▪ Number of Firms in the Industry:

▪ The industry price is $5.00, and we have assumed that the total
number of car washes done in the market area in a week is 8,000;
so there are 10 firms like Blue Velvet in this competitive market
place all earning economic profits.
Three Cost curves [AVC, ATC & MC] and Profit
There are three key cost curves shown in the graph that represents Blue Velvet.
AVC Curve: The average variable cost (AVC) curve shows what happens to the per unit
costs of workers and the other variable factor, soap, as we change output.
Initially as output increases workers can service more cars per hour as they work together,
Output Decisions
thus causing the AVC to decline, but eventually diminishing returns set in and AVC
begins to rise.
ATC Curve: The average total cost curve falls at first in response to the spreading of the
fixed costs over more and more units and eventually begins to rise as the inefficiencies in
labor take their toll.
At the output of 800 washes, the ATC has a value of $4.50. Look back at Table 9.1. The
total cost of Blue Velvet at a service level of 800 cars is $3,600.
MC Curve: Finally, we see the marginal cost (MC) curve, which rises after a certain
point because of the fixed factor of the building and equipment.
Profit: With a price of $5.00, Blue Velvet is producing 800 units and making a profit
(the gray box).
Three Cost curves [AVC, ATC & MC] and Profit
Output Decisions
Important: Firms are producing at a level that is larger than the
output that minimizes average costs
▪ Notice Blue Velvet is producing at a level that is larger than

the output that minimizes average costs.
▪ The high price in the marketplace has induced Blue
Velvet to increase its service level even though the result
Output Decisions
is slightly less labor productivity and thus higher per unit

costs
Firm suffering loss in the Short Run :
Minimizing Losses [Two Category]
▪ A firm that is not earning a positive profit or breaking even is
suffering a loss.
▪
Firms suffering losses fall into two categories:

Output Decisions
▪ (1) those that find it advantageous to shut down operations

immediately and bear losses equal to total fixed costs and
▪ (2) those that continue to operate in the short run to minimize
their losses.
▪ The most important thing to remember here is that firms cannot

exit the industry in the short run.
▪ The firm can shut down, but it cannot get rid of its fixed
costs by going out of business.
▪ Fixed costs must be paid in the short run no matter what the
firm does
Produce/ not to produce in the short run [Loss]
▪ Whether a firm suffering losses decides to produce or not to
produce in the short run depends on the advantages and
disadvantages of continuing production.
▪ If a firm shuts down, it earns no revenue and has no
variable costs to bear.

Output Decisions
▪ If it continues to produce, it both earns revenue and

incurs variable costs.
▪ IMP:
▪ Because a firm must bear fixed costs whether or not it
shuts down, its decision depends solely on whether total
revenue from operating is sufficient to cover total variable
cost.
Produce/ not to produce in the short run [Loss]:
Two conditions
▪ TR > TVC
▪ If total revenue exceeds total variable cost, the excess
revenue can be used to offset fixed costs and reduce
losses, and it will pay the firm to keep operating.
Output Decisions
▪ TR < TVC
▪ If total revenue is smaller than total variable cost, the firm that
operates will suffer losses in excess of fixed costs.
▪ In this case, the firm can minimize its losses by shutting
down.
MINIMIZING LOSSES: Operating Profit
MINIMIZING LOSSES
operating profit (or loss) or net operating revenue Total revenue

minus total variable cost (TR - TVC).
Output Decisions
In general,
■ If revenues exceed variable costs, operating profit is positive

and can be used to offset fixed costs and reduce losses, and
it will pay the firm to keep operating.
■ If revenues are smaller than variable costs, the firm suffers

operating losses that push total losses above fixed costs. In
this case, the firm can minimize its losses by shutting down.
Producing at a Loss to Offset Fixed Costs:
Blue Velvet Revisited
▪ Suppose consumers suddenly decide that car washing is a
waste of money and demand falls.
▪ The price begins to fall, and Blue Velvet is no longer so
profitable.
Output Decisions
▪ We can see what Blue Velvet’s management will decide to do

by looking back at Figure 9.1.
▪ With an upward-sloping marginal cost curve, as price
begins to fall, the Blue Velvet management team first will
choose to reduce the number of cars it services.
▪ As long as the price is greater than ATC (which is
minimized at about $4.35 on the graph), Blue Velvet
continues to make a profit.
▪ What happens if the price falls below this level, say to $3 per
car?
Output Decisions
IF P = $3/Car – Car Wash Owner Decision
▪ Now Blue Velvet has to decide not only how many cars to
wash but whether to be open at all.
▪ If the car wash closes, there are no labor and soap costs.
But Blue Velvet still has to pay for its unbreakable year-long
Output Decisions
contract, and it still owns its building, which will take some
time to sell.
▪ So the fixed costs of $2,000 per week remain
▪ For Blue Velvet, the key question is can it do better than losing $2,000?
▪ The answer depends on whether the market price is greater or less
than average variable costs—the costs per unit for the variable
factors.
Output Decisions
▪ If P > AVC
▪ If the price is greater than the average variable cost, then Blue
Velvet can pay for its workers and the soap and have something
left for the investors.
▪ It will still lose money, but it will be less than $2,000.
▪ If P < AVC
▪ If price is less than average variable cost, the firm will not only lose its
$2,000 but also have added losses on every car it washes.
▪ So the simple answer for Blue Velvet is that it should stay open and
wash cars as long as it covers its variable costs.
▪ Economists call this the shutdown point


The Blue Velvet Revisited
Output Decisions
TABLE 9.2 A Firm Will Operate If Total Revenue Covers Total Variable Cost
CASE 1: SHUT DOWN CASE 2: OPERATE AT PRICE = $3
Total Revenue (q = 0) $ 0 Total Revenue ($3 x 800) $ 2,400

Fixed costs $ 2,000 Fixed costs $ 2,000
Variable costs + 0 Variable costs + 1,600
Total costs $ 2,000 Total costs $ 3,600
Profit/loss (TR - TC) - $ 2,000 Operating profit/loss (TR - TVC) $ 800

Total profit/loss (TR - TC) - $ 1,200
Firm Suffering Losses but Showing an Operating Profit
in the Short Run
Graphic Presentation [Continue Production as long as P > $ 3.10]

Output Decisions
FIGURE 9.2 Firm Suffering Losses but Showing an Operating Profit in the Short Run
AFC & Operating Profit
Remember that average total cost is equal to average

fixed cost plus average variable cost. This means that
at every level of output, average fixed cost is the

Output Decisions
difference between average total and average variable

cost:
ATC = AFC + AVC

or
AFC = ATC - AVC = $4.10 - $3.10 = $1.00
As long as price (which is equal to average revenue per unit)

is sufficient to cover average variable costs, the firm stands to
gain by operating instead of shutting down.
Shutting Down to Minimize Loss [Shut-Down Point]
TABLE 9.3 A Firm Will Shut Down If Total Revenue Is Less Than Total Variable Cost
CASE 1: SHUT DOWN CASE 2: OPERATE AT PRICE = $1.50
Total Revenue (q = 0) $ 0 Total revenue ($1.50 x 800) $ 1,200

Output Decisions
Fixed costs $ 2,000 Fixed costs $ 2,000

Variable costs + 0 Variable costs + 1,600
Total costs $ 2,000 Total costs $ 3,600
Profit/loss (TR - TC): - $ 2,000 Operating profit/loss (TR - TVC) - $ 400

Total profit/loss (TR - TC) - $ 2,400
Any time that price (average revenue) is below the minimum point on the
average variable cost curve, total revenue will be less than total variable cost,
and operating profit will be negative—that is, there will be a loss on operation.
In other words, when price is below all points on the average variable cost
curve, the firm will suffer operating losses at any possible output level the firm
could choose. When this is the case, the firm will stop producing and bear
losses equal to fixed costs. This is why the bottom of the average variable
cost curve is called the shut-down point. At all prices above it, the marginal
cost curve shows the profit-maximizing level of output. At all prices below it,
optimal short-run output is zero.
Shut-Down Point & Short-Run Supply Curve
Shut-down point
The lowest point on the average variable cost curve. When price
falls below the minimum point on AVC, total revenue is insufficient to
cover variable costs and the firm will shut down and bear losses
Output Decisions
equal to fixed costs.
The short-run supply curve of a competitive firm is that portion

of its marginal cost curve that lies above its average variable
cost curve (Figure 9.3).
Short-Run Supply Curve of a Perfectly Competitive Firm
Output Decisions
FIGURE 9.3 Short-Run Supply Curve of a Perfectly Competitive Firm
THE SHORT-RUN INDUSTRY SUPPLY CURVE
▪ Supply in a competitive industry is the sum of the quantity
supplied by the individual firms in the industry at each price
level.
Output Decisions
▪ The short-run industry supply curve is the sum of the

individual firm supply curves—that is, the marginal cost
curves (above AVC) of all the firms in the industry.
▪ Because quantities are being added —that is, because we are

finding the total quantity supplied in the industry at each price
level— the curves are added horizontally
SHORT-RUN CONDITIONS & LONG-RUN DIRECTIONS
THE SHORT-RUN INDUSTRY SUPPLY CURVE
short-run industry supply curve The sum of the marginal cost

curves (above AVC) of all the firms in an industry.

Output Decisions
FIGURE 9.4 The Industry Supply Curve in the Short Run Is the Horizontal Sum of
the Marginal Cost Curves (above AVC) of All the Firms in an Industry
Chapter
9
Long-Run Costs
Prepared by:
Short Run Cost vs Long Run Cost Curve
▪ The shapes of short-run cost curves follow directly from the

assumption of a fixed factor of production.
▪ As output increases beyond a certain point, the fixed factor
(which we usually think of as fixed scale of plant) causes

Output Decisions
diminishing returns to other factors and thus increasing

marginal costs.
▪ In the long run, however, there is no fixed factor of

production.
▪ Firms can choose any scale of production.
▪ They can build small or large factories, double or
triple output, or go out of business completely.
Long Run Cost Curve:
Economies & Diseconomies of scale
▪ The shape of a firm’s long-run average cost curve shows how
costs vary with scale of operations.
▪ In some firms, production technology is such that increased scale, or
size, reduces costs.
▪ For others, increased scale leads to higher per-unit costs.

Output Decisions
▪ Increasing returns to scale :

▪ When an increase in a firm’s scale of production leads to lower
average costs, we say that there are increasing returns to scale, or
economies of scale.
▪ Constant returns to scale

▪ When average costs do not change with the scale of production,
we say that there are constant returns to scale.
▪ Decreasing returns to scale

▪ Finally, when an increase in a firm’s scale of production leads to
higher average costs, we say that there are decreasing returns to
scale, or diseconomies of scale.
Increasing Return to Scale:
Relation between Inputs & Outputs
▪ Technically, the phrase increasing returns to scale refers to the
relationship between inputs and outputs.
▪ When we say that a production function exhibits increasing returns,

we mean that a given percentage of increase in inputs leads to a larger

Output Decisions
percentage of increase in the production of output.

▪ For example, if a firm doubled or tripled inputs, it would more than
double or triple output.
▪ When firms can count on fixed input prices — that is, when the prices
of inputs do not change with output levels — increasing returns to
scale also means that as output rises, average cost of production
falls.
▪ IMP:
▪ The term economies of scale refers directly to this reduction in
cost per unit of output that follows from larger-scale production
Increasing returns to scale:
The Sources of Economies of Scale
▪ Most of the economies of scale that immediately come to mind are
technological in nature.
▪ Automobile production, for example, would be more costly per unit if
a firm were to produce 100 cars per year by hand.
Output Decisions
▪ Some economies of scale result not from technology but from firm-
level efficiencies and bargaining power that can come with size.
▪ Very large companies, for instance, can buy inputs in volume at
discounted prices.
▪ Large firms may also produce some of their own inputs at
considerable savings, and they can certainly save in transport
costs when they ship items in bulk
Example: Economies of Scale in Egg Production
▪ Nowhere are economies of scale more visible than in agriculture.
▪ Consider the following example.

▪ A few years ago a major agribusiness moved to a small Ohio
town and set up a huge egg-producing operation.

Output Decisions
▪ The new firm, Chicken Little Egg Farms Inc., is completely

mechanized.
▪ Complex machines feed the chickens and collect and box the
eggs.
▪ Large refrigerated trucks transport the eggs all over the state
daily.
▪ In the same town, some small farmers still own fewer than 200
chickens.
▪ These farmers collect the eggs, feed the chickens, clean the
coops by hand, and deliver the eggs to county markets.
TABLE 9.5 Weekly Costs Showing Economies of Scale in Egg Production
JONES FARM TOTAL WEEKLY COSTS
15 hours of labor (implicit value $8 per hour) $120
Feed, other variable costs 25
Output Decisions
Transport costs 15
Land and capital costs attributable to egg production 17
$177
Total output 2,400 eggs
Average cost $.074 per egg
CHICKEN LITTLE EGG FARMS INC. TOTAL WEEKLY COSTS

Labor $ 5,128
Feed, other variable costs 4,115
Transport costs 2,431
Land and capital costs 19,230
$30,904
Total output 1,600,000 eggs
Average cost $.019 per egg
Table 9.3 presents some hypothetical cost The costs of Chicken Little Inc. are
data for Homer Jones’s small operation and much higher in total; weekly costs run
for Chicken Little Inc. over $30,000.
▪ A much higher percentage of
costs are capital costs—the firm
Jones has his operation working well.

Output Decisions
▪ He has several hundred chickens and uses a great many pieces of

spends about 15 hours per week feeding, sophisticated machinery that cost
collecting, delivering, and so on. During millions to put in place.
the rest of his time, he raises soybeans.
▪ We can value Jones’s time at $8 per hour Total output is 1.6 million eggs per
because that is the wage he could earn week, and the product is shipped all
working at a local manufacturing plant. over the Midwest.
▪ When we add up all Jones’s costs,
including a rough estimate of the land and The comparatively huge scale of
capital costs attributable to egg production, plant has driven average production
we arrive at $177 per week. costs all the way down to $0.019 per
▪ Total production on the Jones farm runs egg.
about 200 dozen, or 2,400, eggs per
week, which means that Jones’s average
cost comes out to $0.074 per egg.
Long-run average cost curve (LRAC)
Graphic Presentation: long-run average cost curve (LRAC)
A graph that shows the different scales on which a firm can choose to operate in
the long run.
Output Decisions
FIGURE 9.5 Long-run average cost curve (LRAC):

Envelope
Long-run average cost curve (LRAC) – Different Scale
▪ A firm’s long-run average cost curve (LRAC) shows the different

scales at which it can choose to operate in the long run.
▪ A given point on the LRAC tells us the average cost of
producing the associated level of output.
Output Decisions
▪ At that point, the existing scale of plant determines the position

and shape of the firm’s short-run cost curves.
▪ IMP:
▪ The long-run average cost curve shows the positions of the
different sets of short-run curves among which the firm must
choose.
Long-run average cost curve (LRAC) – Envelope
In making the long-run strategic choice of plant scale, the firm then confronts an
associated set of short-run cost curves.
The long-run average cost curve is the “envelope” of a series of short-run curves; It
“wraps around” the set of all possible short-run curves like an envelope.
Output Decisions
FIGURE 9.5 Long-run average cost curve (LRAC):

Envelope
If Economies Of Scale - LRAC will Fall
When the firm experiences economies of scale, its LRAC will decline with output.
Figure 9.5 shows short-run and long-run average cost curves for a firm that realizes
economies of scale up to about 100,000 units of production and roughly constant
returns to scale after that.
Output Decisions
FIGURE 9.5 A Firm Exhibiting Economies of Scale
Minimum efficient scale (MES)
▪ Minimum efficient scale (MES)
▪ The 100,000 unit output level in Figure 9.5 is sometimes
called the minimum efficient scale (MES) of the firm.
▪ The MES is the smallest size at which the long-run

Output Decisions
average cost curve is at its minimum.
▪ Essentially, it is the answer to the question, how large does a

firm have to be to have the best per-unit cost position
possible?
Why the firm should produce MES & Type of Market
atleast MES
▪Consider a firm operating in an ▪Policy makers are often interested in

industry in which all of the firms in learning how large MES is relative to the
Output Decisions
that industry face the long-run total market for a product,

average cost curve shown in Figure ▪Since when MES is large relative
9.5. to the total market size, we
▪If you want your firm to be typically expect fewer firms to be
cost-competitive in that in the industry.
market, you need to produce ▪And, competition may be reduced.
at least 100,000 units.
▪At smaller volumes, you will
have higher costs
than other firms in the
industry, which makes it hard
for you to stay in the industry.
Three Scale of Operation
[with their own short-run cost curves]
▪ Figure 9.5 shows three potential scales of operation, each
with its own set of short-run cost curves.
▪ Once the firm chooses a scale on which to produce, it

Output Decisions
becomes locked into one set of cost curves in the short run.
▪ If the firm were to settle on scale 1, it would not realize the
major cost advantages of producing on a larger scale.
▪ By roughly doubling its scale of operations from 50,000 to
100,000 units (scale 2), the firm reduces average costs
per unit significantly
Three Scale of Operation:
A Firm Exhibiting Economies of Scale
Output Decisions
Firm faces two different cost constraints
▪ Figure 9.5 shows that at every moment, firms face two different
cost constraints.
▪
In the long run, firms can change their scale of operation, and
Output Decisions
costs may be different as a result.

▪ However, at any given moment, a particular scale of operation
exists, constraining the firm’s capacity to produce in the short
run.
▪ That is why we see both short- and long-run curves in the same
diagram
▪ The long-run average cost curve of a firm shows the different

scales on which the firm can choose to operate in the long run.
▪ Each scale of operation defines a different short run.
▪ Economies of Scale (Fig 9.5):

▪ Here we see a firm exhibiting economies of scale; moving from
scale 1 to scale 3 reduces average cost.
FIGURE 9.5: A Firm Exhibiting Economies of Scale
Output Decisions
LONG-RUN COSTS:CONSTANT RETURNS TO SCALE
CONSTANT RETURNS TO SCALE LRAC will be flat, straight line
Technically, the term constant In Figure 9.5:

returns means that the quantitative The firm exhibits roughly constant
relationship between input and returns to scale between scale 2 and
Output Decisions
output stays constant, or the same, scale 3.

when output is increased. The average cost of production is
If a firm doubles inputs, it doubles about the same in each.
output; if it triples inputs, it triples
output; and so on.
If the firm exhibited constant returns
at levels above 150,000 units of
Furthermore, if input prices are fixed, output, the LRAC would continue as
constant returns imply that average a flat, straight line
cost of production does not change
with scale.
IMP:Constant returns to scale mean

that the firm’s long-run average cost
curve remains flat.
CONSTANT RETURNS TO SCALE
[Between scale 2 & 3]
Output Decisions
LONG-RUN COSTS:
DECREASING RETURNS TO SCALE
▪ When average cost increases with scale of production, a firm faces
decreasing returns to scale, or diseconomies of scale.
▪ Reason
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▪ The most often cited example of a diseconomy of scale is

bureaucratic inefficiency.
▪ As size increases beyond a certain point, operations tend to
become more difficult to manage.
▪ The coordination function is more complex for larger firms than for
smaller ones, and the chances that it will break down are greater.
▪ A large firm is also more likely than a small firm to find itself
facing problems with organized labor.
▪ Unions can demand higher wages and more benefits, go on strike,
force firms to incur legal expenses, and take other actions that
increase production costs. (This does not mean that unions are
“bad,” but instead that their activities often increase costs.)
DECREASING RETURNS TO SCALE
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FIGURE 9.6 A Firm Exhibiting DECREASING RETURNS TO SCALE

Shape of LRAC
▪ Shape of LRAC:
▪ The shape of a firm’s long-run average cost curve depends
on how costs react to changes in scale.
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▪ Some firms do see economies of scale, and their long-run

average cost curves slope downward.
▪ Most firms seem to have flat long-run average cost
curves.
▪ Still others encounter diseconomies, and their long-run
average cost curves slope upward
U Shaped LRAC
[Economies Of Scale & Diseconomies Of Scale ]
▪ Figure 9.6 describes a firm that exhibits both economies of scale and
diseconomies of scale.
▪ Average costs decrease with scale of plant up to q* and increase

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with scale after that.
▪ Economies of scale push this firm’s average costs down to q*.

▪ Beyond q*, the firm experiences diseconomies of scale;
▪ q* is the level of production at lowest average cost, using optimal

scale.
FIGURE 9.6:A Firm Exhibiting Economies and Diseconomies of Scale
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FIGURE 9.6 A Firm Exhibiting Economies and Diseconomies of Scale
Important (Similar shape of SRAC & LRAC)
▪ The U-shaped average cost curve looks very much like the
short-run average cost curves
▪ All short-run average cost curves are U-shaped because we
assume a fixed scale of plant that constrains production

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and drives marginal cost upward as a result of diminishing

returns.
▪ In the long run, we make no such assumption; instead, we
assume that scale of plant can be changed and ask how
costs change with scale
Optimal scale of plant
It is important to note that economic efficiency requires taking
advantage of economies of scale (if they exist) and avoiding
diseconomies of scale.
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optimal scale of plant The scale of plant that minimizes average

cost.
▪ In fact, competition forces firms to use the optimal scale.
▪ In Figure 9.6, q* is the unique optimal scale.
Long-run adjustments to short-run conditions
Different Short-Run Positions:
We began this chapter by discussing the different short-run positions in
which firms like Blue Velvet may find themselves.
▪ Firms can be operating at a profit or suffering economic losses;
▪
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They can be shut down or producing.
Short-Run Profits: Moves In and Out of Equilibrium

Suppose demand increases when the industry is in long-run equilibrium.
What will happen?
But what is long-run equilibrium?
Long Run Equilibrium
▪ The industry is not in long-run equilibrium if firms have an incentive to

enter or exit in the long run.
▪ Thus, when firms are earning economic profits (profits above
normal, or positive) or are suffering economic losses (profits below
normal, or negative), the industry is not at an equilibrium and

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firms will change their behavior.
Long Run Equilibrium => Profit is zero => No entry or exit
Long-run adjustments to short-run conditions:
Industry in Equilibrium but Increase in Demand
[Case I: Equilibrium => Short-Run Profits]
▪ Consider a competitive market in which demand and costs have been

stable for some period and the industry is in equilibrium.
▪ The market price is such that firms are earning a normal rate of
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return and the flow of firms in and out of the industry balances out.
▪ Firms are producing as efficiently as possible, and supply equals

demand.
▪ Industry in Equilibrium:
▪ Figure 9.6 shows this situation at a price of $6 and an output of
200,000 units for an industry with a U-shaped long-run cost curve.
▪ The individual firm on the right is producing 2,000 units, and so we
also know that the industry consists of 100 firms.
▪ All firms are identical, and all are producing at the uniquely best
output level of 2,000 units.
FIGURE 9.6: Equilibrium for an Industry with U-shaped Cost Curves
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Industry in Equilibrium but Industry in Equilibrium but
Increase in Demand Increase in Demand =>
Firm will increase output
Now suppose demand increases. In Figure 9.7, firms will move up their
Perhaps this is the market for green tea, SRMC curves as they produce output
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and there has been a news report on the beyond the level of 2,000.
health benefits of the tea.
Why do firms do this?
What happens? Managers at the firms Because the increased demand has
notice the demand increase increased the price.
But each firm has a fixed capital stock — The new higher price makes it worthwhile
it owns a set tea plantation, for example. for the firms to increase their output even
though in the short run it is expensive to
Entry also is impossible in the short run. do so.
But existing firms can do something to
meet the new demand, even within the In fact, the firms increase output as long
constraints of their existing plant. as the new price is greater than the
short-run marginal cost curve.
They can hire overtime workers, for
example, to increase yield. We have noted the new short-run
But this increases average costs equilibrium in Figure 9.7.
Industry in Equilibrium but Increase in Demand –
Firm will increase output [new short-run equilibrium]
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Industry in Equilibrium but Increase in Demand –
New short-run equilibrium but with New short-run equilibrium but What happens
two differences next?
Again supply equals demand. But Other entrepreneurs observing the industry
there are two important differences. see the excess profits and enter.
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Each one enters at a scale of 2,000 because

First, and most important, firms are that is the optimal scale in this industry.
making profits. Perhaps existing firms also build new plants.
The profits are noted in the gray-
shaded rectangle in Figure 9.7 and are With each new entry, the industry supply
the difference between the new higher curve (which is just the sum of all the
price and the new higher average cost. individual firms’ supply curves) shifts to the
right.
Second, firms are also operating at More supply is available because there are
too large an output level for more firms. Price begins to fall.
minimum average cost.
Managers in these firms are As long as the price is above $6, each of the
scrambling to get increased output firms, both old and new, is making excess
from a plant designed for a smaller profits and more entry will occur.
output level. Once price is back to $6, there are no longer
excess profits and thus no further entry.
Figure 9.8: New equilibrium with Higher Demand
[Shift in SS curve so that Industry returns to the original price of $6 at a new
quantity level]
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Characteristics of the new equilibrium
▪ Again, notice the characteristics of the final equilibrium:
▪ Each individual firm chooses a scale of operations that
minimizes its long-run average cost.
▪ It operates this plant at an output level that minimizes short-run
average cost.
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▪ In equilibrium, each firm has

SRMC = SRAC = LRAC
▪ Firms make no excess profits so that

P = SRMC = SRAC = LRAC
and there are enough firms so that supply equals demand
LONG-RUN ADJUSTMENTS TO
SHORT-RUN CONDITIONS: Summary
Firms will continue to expand as long as there are economies of

scale to be realized, and new firms will continue to enter as long as
positive profits are being earned.
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In the long run, equilibrium price (P*) is equal to long-run average

cost, short-run marginal cost, and short-run average cost.
Profits are driven to zero:
P* = SRMC = SRAC = LRAC
where SRMC denotes short-run marginal cost, SRAC denotes short-

run average cost, and LRAC denotes long-run average cost. No other
price is an equilibrium price.
Any price above P* means that there are profits to be made in the
industry, and new firms will continue to enter.
Any price below P* means that firms are suffering losses, and firms
will exit the industry.
Only at P* will profits be just equal to zero, and only at P* will the
industry be in equilibrium.
Long-run adjustments to short-run conditions:
Industry in Equilibrium but Decrease in Demand
[Case II: Equilibrium -> SHORT-RUN LOSSES:
Short-Run Loss] CONTRACTION TO EQUILIBRIUM
Suppose instead of a positive demand At this point, firms earn losses and
shock, the industry experiences an are producing at too small a level

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unexpected cut in demand. and thus have higher average cost

When demand falls (shifts to the left), than before.
the price falls. Some firms drop out, and when
they do so, the supply curve shifts
to the left.
In the short run, firms cannot shrink
plants, nor can they exit.
But with the lower price, firms begin to
produce less in their plants than How many firms leave?
before. Enough so that the equilibrium is
In fact, firms cut back production so restored with the price again at $9
long as the price they receive is less and the industry output has fallen
than their short-run marginal cost. reduced to reflect the reduced
demand for the product.
SHORT-RUN LOSSES: CONTRACTION TO EQUILIBRIUM
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FIGURE 9.8 Long-Run Contraction and Exit in an Industry Suffering Short-Run Losses
LONG-RUN ADJUSTMENTS TO
SHORT-RUN CONDITIONS
As long as losses are being sustained in an industry, firms will shut

down and leave the industry, thus reducing supply—shifting the
supply curve to the left. As this happens, price rises. This gradual
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price rise reduces losses for firms remaining in the industry until
those losses are ultimately eliminated.
Whether we begin with an industry in which firms are earning profits

or suffering losses, the final long-run competitive equilibrium
condition is the same:
P* = SRMC = SRAC = LRAC
and profits are zero.

At this point, individual firms are operating at the most efficient scale
of plant—that is, at the minimum point on their LRAC curve.
THE LONG-RUN ADJUSTMENT MECHANISM:
INVESTMENT FLOWS TOWARD PROFIT OPPORTUNITIES
In efficient markets, investment capital flows toward profit

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opportunities.
The actual process is complex and varies from industry to
industry.
Long-run competitive equilibrium
long-run competitive equilibrium When P = SRMC = SRAC =

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LRAC and profits are zero.
Investment — in the form of new firms and expanding old

firms — will over time tend to favor those industries in
which profits are being made, and over time industries in
which firms are suffering losses will gradually contract from
disinvestment.
Investment flows toward profit opportunities
through the financial capital market
▪ The central idea in our discussion of entry, exit, expansion,
and contraction is this:
▪
In efficient markets, investment capital flows toward profit

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opportunities.
▪ In efficient markets, profit opportunities are quickly eliminated
as they develop.
▪ Profits in competitive industries also are eliminated as new
competing firms move into open slots, or perceived
opportunities, in the industry
▪ In practice, the entry and exit of firms in response to profit

opportunities usually involve the financial capital market.
▪ In capital markets, people are constantly looking for profits.
▪ When firms in an industry do well, capital is likely to flow
into that industry in a variety of forms.
Example of an expanding Industry
▪ A powerful example of an industry expanding with higher prices and
higher economic profits is the housing sector prior to 2007.
▪ From the late 1990s until early 2006, the housing market was booming
nationally.
▪ Demand was shifting to the right for a number of reasons.

Output Decisions
▪ As it did, housing prices rose substantially and with them the profits
being made by builders.
▪ As builders responded with higher output, the number of new units
started (housing starts) increased to a near record level of over 2.2
million per year in 2005.
▪ Construction employment grew to over 7.5 million.
▪ Starting in 2006, housing demand shifted to the left.
▪ The inventory of unsold property began to build, and prices started to
fall.
▪ That turned profits into losses.
▪ Home builders cut their production, and many went out of business.
▪ These moves had major ramifications for the performance of the whole
economy.
Profit – Firms Invest &
Loss – Firms Contract
▪ When there is promise of positive profits, investments
are made and output expands.
▪ When firms end up suffering losses, firms contract
and some go out of business.
Output Decisions
▪ It can take quite a while, however, for an industry to achieve

long-run competitive equilibrium, the point at which
P = SRMC = SRAC = LRAC and profits are zero.
WHY DO COMPETITIVE FIRMS STAY IN BUSINESS IF
THEY MAKE ZERO PROM?
A first, it might seem odd that competitive firms earn zero profit in the long run. After
all, people start make a profit. If entry eventually drives profit to zero, there
might seem to be little reason to in business.
Consider an example. Suppose that a farmer had to invest $1 million to open his
Output Decisions
farm, which otherwise he could have deposited in a bank to earn $50,000 a

year in interest. In addition, he had to give up another job that would have paid
him $30,000 a year. Then the farmer’s opportunity cost of farming includes
both the interest he could have earned and the forgone wages-a total of
$80,000: Even if his profit is driven to zero, his revenue from farming
compensates him for these opportunity costs.
Keep in mind that accountants and ‘economists measure costs differently. As we

discussed in the previous chapter, accountants keep track of explicit costs but
not implicit costs. That is, way measure costs that require an outflow of money
from the firm, but they do not include the opportunity costs of production that
do not involve an outflow of money. As a result, in the zero-profit equilibrium,
economic profit is zero, but accounting profit is positive. Our farmer’s
accountant, for instance, would conclude that the farmer earned an accounting
profit of $80,000, which is enough to keep the farmer in business.
The U-shaped curve:
For a particular level of equipment and scale the average cost of a firm is
represented by a U-shaped curve. Suppose U1, U2, and U3 in Fig. 7.5, are
three different short run average cost curves for three different scales of
production. For each of these scales there is an optimum output. The producer
would ordinarily like to produce the optimum output because his average cost
Output Decisions
is least at this point. But if demand changes it may be necessary to increase

or decrease his output and he may consider it desirable to alter his scale of
production.
Suppose at a particular time, a producer is under cost curve U2 and produces OQ0.
He finds it necessary to produce OQ1. If he continues under the old scale his
average cost will be Q1T. Suppose he alters his scale so that his new cost
curve is U3. The average cost of producing OQ1 is now Q1A. Q1A is less than
Q1T. So the new scale is preferable to the old and will be adopted. In the long
run the average cost has changed from Q0R to Q1A.
Output Decisions
Relationship between the long-run cost curve and
the short-run cost curves:
The long-run cost curve is a curve which shows how costs change when the scale of
production is changed. This curve is obtained by drawing a line which touches
the series of possible short-run cost curves. In Fig. 7.5 LRAC is such a line.
Mathematically speaking LRAC is the envelope of U1, U2, U3, etc.
Output Decisions
The long-run cost curve is the locus of equilibrium point on the short-run cost curves.
At the equilibrium points, a movement along the short-run cost curve and a
movement along the long-run cost curve must involve the same change of cost.
That is, the short-run and the long-run marginal costs must be equal. This
condition is satisfied only if the long-run average cost curve is tangential to the
short- run average cost curves.
Chapter
9
Long-Run Costs
Prepared by:
Output Decisions
PRACTICE SUMS
Compre Exam (IInd Sem 22-23)
Output Decisions
Answer:
1. 14
Output Decisions
6. 25
14. Increasing returns to scale/ Economies of scale
20. Zero
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Output Decisions
From Earlier Semester’s
Output Decisions
IInd Sem 2018-19
⚫ Question No. 4:
Analyse the figure given below
and answer the following
questions.
⚫ Draw the diagram as given
above and for each case given
below: indicate the equilibrium
points in the figure, write the
equilibrium condition, explain
short run decision with reasons
and long run decision
a. Market price of Rs. 11
b. Market price of Rs. 7
c. Market price of Rs. 5
d. Market price of Rs. 3
8-89
⚫ a) Mkt. price of 11
– Equilibrium Condition: P=MC (Point
A)
– Short Run: TR>TC (Profit); Existing
firm will try to expand & Operate in
the short run
– Long Run: Existing firm expands &
New firm enters
⚫ b) Mkt. price of 7
B)
– Short Run: TR<TC but TR>TVC
(Operating Profit); Existing firm will try
to minimize their losses by operating
in the short run.
– Long Run: Exit
8-90
⚫ c) Mkt. price of 5
C)
– Short Run: Shut down
– Long Run: Exit
⚫ d) Mkt. price of 2
– Equilibrium Condition: Zero supply
(No equilibrium)
– Short Run: No production (MC curve
doesn’t represent SS curve below the
lowest point of AVC)
– Long Run: Exit
8-91
Quiz-IV [IInd Sem 2021-22]
Output Decisions
CHAPTER 9: Long-Run Costs and Q1
Output Decisions
Answer: (c)
Answer: (c)
Output Decisions
Q3
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Answer: (a)
Output Decisions
Q5
Output Decisions
Answer: (d)
Output Decisions
Output Decisions
Q7
Answer: (b)
Answer: (e)
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100 of
Q8
Output Decisions
101 of
Answer: (b)
Answer: (a)
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102 of
Q10
Output Decisions
103 of
Answer: (d)
Answer: (d)
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104 of
Previous Semester’s Questions
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105 of
Q1:
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Ans: (ii) [q=10 & P=25]
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Q2:
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Ans: (a) Increase
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Q3:
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Ans: (b) Increasing return to scale
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Q4:
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Ans: (d) 1900
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Q5:
Which of the following statements are true? Multiple answers possible.

(i) MES, if it exists, is going to be unique.
(ii) Optimal scale, if it exists, is always going to be unique.

Output Decisions
(iii) Existence of MES implies the existence of optimal scale.

(iv) Existence of optimal scale implies the existence of MES.
(i),(ii) & (iv) are true

(i), (iii) & (iv) are true
All are true
(iii) & (iv) are true
(i) & (iii) are true
Which of the following statements are true? Multiple answers possible.
(i) MES, if it exists, is going to be unique.
(ii) Optimal scale, if it exists, is always going to be unique.

Output Decisions
(iii) Existence of MES implies the existence of optimal scale.

(iv) Existence of optimal scale implies the existence of MES.
(i),(ii) & (iv) are true

(i), (iii) & (iv) are true
All are true
(iii) & (iv) are true
(i) & (iii) are true
Q6:
Consider the market for hard red winter wheat. You know that there are numerous firms in the market, all
of which are relatively small. Assume further that there are no entry costs that cannot be recovered
on exiting the industry. Suppose that a health fad emerges in the U.S. that discourages the
consumption of natural grains and cereals. What will be the effect on profits of wheat farmers, the
price of wheat and output in both the short-run and the long-run? (Assume that input prices are
constant over the relevant range.)

Output Decisions
a) price, quantity and profits will fall in the short-run but remain constant in the long-run.
b) price, quantity and profits will fall in both the short-run and the long-run.
c) quantity will fall in both the short and the long-run, price will fall in the short-run but remain
constant in the long-run, profits will fall in the short-run but fall to zero in the long-run.
d) price and quantity will decrease in both the short and the long-run while profits, although initially
falling, will fall to zero in the long-run.
e) while price, quantity, and profits will fall in the short-run it is impossible to predict what will happen
in the long-run.
Consider the market for hard red winter wheat. You know that there are numerous firms in the market, all
of which are relatively small. Assume further that there are no entry costs that cannot be recovered
on exiting the industry. Suppose that a health fad emerges in the U.S. that discourages the
consumption of natural grains and cereals. What will be the effect on profits of wheat farmers, the
price of wheat and output in both the short-run and the long-run? (Assume that input prices are
constant over the relevant range.)

Output Decisions
a) price, quantity and profits will fall in the short-run but remain constant in the long-run.
b) price, quantity and profits will fall in both the short-run and the long-run.
c) quantity will fall in both the short and the long-run, price will fall in the short-run but remain
constant in the long-run, profits will fall in the short-run but fall to zero in the long-run.
d) price and quantity will decrease in both the short and the long-run while profits, although initially
falling, will fall to zero in the long-run.
e) while price, quantity, and profits will fall in the short-run it is impossible to predict what will happen
in the long-run.
Q7:
What kind of returns to scale does the following production functions

exhibit respectively:
PF 1: F(z1, z2) = min{2z1, z2}
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PF 2: F(z1, z2) = z11/2 + z2
Both increasing return to scale.

Both decreasing return to scale.
Both constant return to scale.
Increasing return to scale & decreasing return to scale
Decreasing return to scale & increasing return to scale
None of the given options
What kind of returns to scale does the following production functions
exhibit respectively:
PF 1: F(z1, z2) = min{2z1, z2}
Output Decisions
PF 2: F(z1, z2) = z11/2 + z2
Both increasing return to scale.

Both decreasing return to scale.
Both constant return to scale.
Increasing return to scale & decreasing return to scale
Decreasing return to scale & increasing return to scale
None of the given options [Constant & DRS]
Output Decisions
THANK YOU
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Chapter

Fernando & Yvonn Quijano

Short-Run Conditions and Long-

▪ Firms use information on input prices, output prices, and technology

will cost, using the most efficient technology.

For Profit (MR=MC)

▪You are stuck with a particular factory and set

of machines, and your decisions involve asking

▪ Long-run cost curves need

▪ As we saw in the short run, a fixed not slope up at all.

(1) firms earning economic profits,

(2) firms suffering economic losses but continuing to operate to

▪ A normal rate of return is a rate that is just sufficient to keep

and because total cost includes a normal rate of return, our

concept of profit takes into account the opportunity cost of

▪ Earning greater than Normal rate of return

▪ Earning exactly Normal rate of return

▪ (2) the firm is suffering losses, or

▪ (3) the firm is just breaking even.

breaking even The situation in which a firm is earning exactly a

Profitable firms will want to maximize their profits in the short

the equipment required to wash contract on the equipment is $50,000 per

▪ Workers can be hired by the hour for

TABLE 9.1 Blue Velvet Car Wash Weekly Costs

TOTAL VARIABLE COSTS TOTAL COSTS

1. Normal return to investors $ 1,000 1. Labor $ 1,000 Total revenue (TR)

2. Other fixed costs $ 1,600 Profit (TR - TC) $ 400

FIGURE 9.1 Firm Earning Positive Profits in the Short Run

▪ A profit-maximizing perfectly competitive firm will produce up to the

▪ total revenue is $5 * 800 = $4,000,

▪ total cost is $4.50 * 800 = $3,600, and

▪ Number of Firms in the Industry:

FIGURE 9.1 Firm Earning Positive Profits in the Short Run

▪ Notice Blue Velvet is producing at a level that is larger than

is slightly less labor productivity and thus higher per unit

Firms suffering losses fall into two categories:

▪ (1) those that find it advantageous to shut down operations

▪ The most important thing to remember here is that firms cannot

variable costs to bear.

▪ If it continues to produce, it both earns revenue and

operating profit (or loss) or net operating revenue Total revenue

■ If revenues exceed variable costs, operating profit is positive

■ If revenues are smaller than variable costs, the firm suffers

▪ We can see what Blue Velvet’s management will decide to do

FIGURE 9.1 Firm Earning Positive Profits in the Short Run

▪ Economists call this the shutdown point

Producing at a Loss to Offset Fixed Costs:

Total Revenue (q = 0) $ 0 Total Revenue ($3 x 800) $ 2,400

Profit/loss (TR - TC) - $ 2,000 Operating profit/loss (TR - TVC) $ 800

Graphic Presentation [Continue Production as long as P > $ 3.10]

Remember that average total cost is equal to average

at every level of output, average fixed cost is the

difference between average total and average variable

ATC = AFC + AVC

As long as price (which is equal to average revenue per unit)

Total Revenue (q = 0) $ 0 Total revenue ($1.50 x 800) $ 1,200

Fixed costs $ 2,000 Fixed costs $ 2,000

Profit/loss (TR - TC): - $ 2,000 Operating profit/loss (TR - TVC) - $ 400

equal to fixed costs.

The short-run supply curve of a competitive firm is that portion

FIGURE 9.3 Short-Run Supply Curve of a Perfectly Competitive Firm

▪ The short-run industry supply curve is the sum of the

▪ Because quantities are being added —that is, because we are