BackShort-Run Production Decisions and Profit Calculation in Perfect Competition
Study Guide - Smart Notes
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Short-Run Production Decisions
Understanding Costs and Revenues
In the short run, firms must decide whether to produce or shut down based on their costs and the market price. The following table summarizes the cost structure for a firm producing edible underpants:
Quantity | Total Fixed Costs | Total Variable Costs |
|---|---|---|
0 | 100 | 0 |
1 | 100 | 50 |
2 | 100 | 70 |
3 | 100 | 90 |
4 | 100 | 140 |
5 | 100 | 200 |
Total Cost (TC) is the sum of Total Fixed Costs (TFC) and Total Variable Costs (TVC):
Total Revenue (TR) is the price per unit multiplied by the quantity sold:
Profit (\pi) is the difference between total revenue and total cost:
Shut Down Decision
Shut Down Rule: In the short run, a firm should shut down if the price is less than the average variable cost (AVC) at all output levels.
Average Total Cost (ATC):
Average Variable Cost (AVC):
If , the firm should shut down.
Example: If the price is $50 and the AVC at all output levels is higher than $50, the firm should shut down.
Profit Maximization and Loss Minimization
Marginal Cost (MC): The change in total cost from producing one more unit.
Profit Maximization: Occurs where (in perfect competition, ).
Loss Minimization: If the firm cannot make a profit, it should produce the quantity where losses are minimized, as long as .
Example: If producing four units minimizes the firm's loss, the firm should produce four units in the short run.
Calculating Total Revenue and Profit
Total Revenue
Formula:
Example: If and , then .
Profit or Loss Calculation
Formula:
Example: If and , then (a $40 loss).
Summary Table: Short-Run Output and Profit Analysis
Quantity | Total Cost (TC) | Total Revenue (TR) | Profit (\pi) |
|---|---|---|---|
0 | 100 | 0 | -100 |
1 | 150 | 50 | -100 |
2 | 170 | 100 | -70 |
3 | 190 | 150 | -40 |
4 | 240 | 200 | -40 |
5 | 300 | 250 | -50 |
Additional info: Table values for profit are calculated using the formulas above. The firm minimizes its loss at 3 or 4 units, with a $40 loss.
Key Terms
Short Run: A period in which at least one input is fixed.
Fixed Costs: Costs that do not vary with output.
Variable Costs: Costs that change with the level of output.
Marginal Cost: The additional cost of producing one more unit.
Average Total Cost: Total cost divided by quantity produced.
Shut Down Point: The output and price at which a firm covers its variable costs but not its fixed costs.
