Lecture 14 Short Run Decision Making

1
Lecture 14Short Run Decision Making

• Firms Problem determine which level of Q will
  maximize profits.
• Determining the p maxing Q requires comparing the
  costs and benefits of producing a unit of output.
• The cost of producing an additional unit of
  output is
• The benefit of producing an additional unit of
  output is

2

• Assume that MR is constant and equal to the price
  at which the firm sells output.

3
Rules for choosing the best (optimal) level of Q
to produce
4
Evaluating Profits in the Short Run

1. p TR-TC

5
There are 3 different possible levels for profit
(p) and 2 possible decisions about production (Q)

• Case 1
• Case 2
• Case 3
• Case 4

6
Case 1 p gt 0 ? TR gt TC and P gt ATC
TR P x Q TC ATC x Q p TR TC
7
Case 2 p 0 ? TR TC and P ATC
TR 0 P2 A q TC 0 P2 A q p 0
8
Contemplating Cases 3 4

• In the Short Run
• The firm must pay its TFC even if it produces 0
  output because it can not change K.
• The maximum loss the firm must ever incur equals
  TFC, the loss that would occur if the firm shut
  down.
• The firm can lose less than TFC when operating
  only if TR gt TVC (? P gt AVC) because revenues
  cover all variable costs and some of the fixed
  costs.
• If TR lt TVC (? P lt AVC) the firm is unable to pay
  some of the variable costs and all of the fixed
  costs. The firm minimizes losses by shutting down
  and eliminating the losses associated with the
  variable input.

9
Case 3 produce at a loss p lt 0 ? TC gt
TR but TR gt TVC ? ATC gt P but P
gt AVC
TR 0 P3 A q TC 0 B C q losses P3 B C A
10
Case 4 shut down p lt 0 ? TC gt TVC gt
TR ? ATC gt AVC gt P

• If the firm produced
• TR 0 P4 A q TC 0 B C q losses P4
  B C A
• shut down minimizes losses because
• TFC 0 D E q lt losses P2 B C A
• minimum AVC is the shut down point

11
SR Equilibrium Conditions for the Firm
12
SR Supply Curve for the Firm