Scot Wick Blog

  Mostly summarized from Gregory Mankiw’s Principles of Economics, 5th Ed. PART 5 Firm Behavior and the Organization of Industry Chapter 14 of 36 - Firms In Competitive Markets Section 19 of 22 ... Why do firms in competitive markets stay in business if they make zero profit at price = average total cost? It is because average total cost includes implicit cost. Accountants calculate explicit costs that cause a money flow but do not consider implicit costs which do not. … Per Table A, year 1 A farmer’s sales revenue for the year is $250,000 and has explicit paid-out costs of $150,000. The farmer's accountant calculates he earns an accounting profit of A – B = $100,000 Originally the farmer invested $1,000,000 to start his farm. He could have instead put his money in the stock market for an average profit of 5% producing a yearly income of $50,000. He also had to give up a job that paid a salary of $50,000. These two $50,000 + $50,000 = $100,000, are implicit non-cash-flow costs. Co...

  Mostly summarized from Gregory Mankiw’s Principles of Economics, 5th Ed. PART 5 Firm Behavior and the Organization of Industry Chapter 14 of 36 - Firms In Competitive Markets Section 18 of 22 … Per Figure 7 panel (a) In the long run firms enter or exit the market until economic profit is driven to zero. If price (P) > average total costs (ATC) there are profits, this encourages new firms to enter the market. If P < ATC there are losses, this encourages some existing firms to exit the market. … The process of firms entry into and exit from the market ends when P settles at ATC. Each competitive firm maximizes profits (or minimizes losses) by choosing a quantity at which P = marginal cost (MC). Market free entry and exit eventually forces P = ATC. Therefore at market equilibrium, P = MC = ATC and there is no further market entry and exit. MC = ATC only when the firm is operating at minimum ATC. … Panel (a) shows a firm’s long-run equilibrium lowest cost efficient scale. P ...

  Mostly summarized from Gregory Mankiw’s Principles of Economics, 5th Ed. PART 5 Firm Behavior and the Organization of Industry Chapter 14 of 36 - Firms In Competitive Markets Section 16 of 22 … Figure 6 - Short-Run Market Supply In the short run, the number of firms in the market is fixed. As a result the market supply curve, panel (b) reflects the individual firms' marginal-cost curves of panel (a). Here, in a market of 1,000 firms the quantity of output supplied to the market is 1,000 times the quantity of 100 supplied by each firm. … Table 2 and Figure 4 from Chapter 13 attached for reference review of marginal cost components. … There are two market supply curve cases to consider · short-run situation: a market with a fixed number of firms · long-run situation: a market where the number of firms change as firms exit and enter the market Over short periods of time it is difficult for firms to quickly enter and exit a market, so the assumption is there are a fixed number of fir...

  Mostly summarized from Gregory Mankiw’s Principles of Economics, 5th Ed. PART 5 Firm Behavior and the Organization of Industry Chapter 14 of 36 - Firms In Competitive Markets Section 15 of 22 … Figure 5 - Profit as the Area between Price and Average Total Cost The area of the shaded box between price and average total cost (ATC) is the firm's profit, or loss. Height of this box is price (P) minus average total cost, P – ATC (profit per unit). Width of the box is the output quantity, (Q). Panel (a), P is above ATC, the firm has profit. Panel (b), P is below ATC, the firm has loss. … Panel (a) shows a firm with a profit. A firm maximizes profit by producing the Q at which P = MC (MC being average variable costs). The area of the rectangle (P - ATC) x Q is the firm's profit. … Panel (b) shows a firm with a loss . Here the firm wants to minimize losses. This is also achieved by producing the Q where P = MC. The area of the rectangle (ATC - P) x Q is the firm's loss. … A firm ...

  Mostly summarized from Gregory Mankiw’s Principles of Economics, 5th Ed. PART 5 Firm Behavior and the Organization of Industry Chapter 14 of 36 - Firms In Competitive Markets Section 14 of 22 … Figure 4 - The Competitive Firm's Long-Run Supply Curve In the long run for the competitive firm supply curve is its marginal cost (MC) curve above average total cost (ATC) curve. If the firm’s product price falls and stays below ATC, the firm exits the market. This exit is caused by either · fall in price, e.g. caused by fall in demand or competition · increase in ATC, e.g. caused by increasing labor or raw materials costs · no expectations of future profits … A similar analysis applies to an entrepreneur who is considering starting a firm and entering a market. The firm will enter the market if the investor believes it would be profitable in the long run, which occurs when the price of the good > ATC of production. Per Figures A and B Amazon was founded in 1994 but only started earnin...

  Mostly summarized from Gregory Mankiw’s Principles of Economics, 5th Ed. PART 5 Firm Behavior and the Organization of Industry Chapter 14 of 36 - Firms In Competitive Markets Section 13 of 22 … Why does an almost empty restaurant stay open? It might seem the revenue from the few customers does not cover the cost of running the restaurant. A restaurant owner makes a distinction between fixed and variable costs. Many of a restaurant's costs are fixed, including rent, kitchen equipment, tables, plates, and silverware. Shutting down during lunch would not reduce these fixed costs, they are sunk in the short run. … When the owner is deciding whether serve lunch, only the variable costs are relevant including the costs of the additional food ingredients and staff wages. The owner shuts down the restaurant at lunchtime only if the revenue from the few lunchtime customers does not cover the restaurant's variable costs incurred serving them. … An owner of a miniature golf course makes...

  Mostly summarized from Gregory Mankiw’s Principles of Economics, 5th Ed. PART 5 Firm Behavior and the Organization of Industry Chapter 14 of 36 - Firms In Competitive Markets Section 12 of 22 … Economists say a cost is a “sunk cost” when it is committed and cannot be recovered. Because nothing can be done about sunk costs a firm can ignore them when making decisions. A firm cannot recover its fixed costs by temporarily stopping production. Regardless of the quantity of output supplied, even if zero, the firm still has to pay its fixed costs. As a result, fixed costs are sunk in the short run and are ignored when deciding how much to produce. … Consider you place a $15 value on seeing a newly released movie, you would pay up to $15 to see it. You buy a ticket for $10, but you lose the ticket before entering the theater. Should you buy another ticket? Should you go home and refuse to pay a total of $20 to see the movie? The answer is you should buy another ticket. The $15 benefit o...