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As discussed in the chapter on Demand and Supply , many of the reasons that supply curves shift relate to underlying changes in costs. For example, a lower price of key inputs or new technologies that reduce production costs cause supply to shift to the right; in contrast, bad weather or added government regulations can add to costs of certain goods in a way that causes supply to shift to the left. These shifts in the firm’s supply curve can also be interpreted as shifts of the marginal cost curve. A shift in costs of production that increases marginal costs at all levels of output—and shifts MC to the left—will cause a perfectly competitive firm to produce less at any given market price. Conversely, a shift in costs of production that decreases marginal costs at all levels of output will shift MC to the right and as a result, a competitive firm will choose to expand its level of output at any given price. The following Work It Out feature will walk you through an example.
To determine the short-run economic condition of a firm in perfect competition, follow the steps outlined below. Use the data shown in [link] .
| Q | P | TFC | TVC | TC | AVC | ATC | MC | TR | Profits |
|---|---|---|---|---|---|---|---|---|---|
| 0 | $28 | $20 | $0 | - | - | - | - | - | - |
| 1 | $28 | $20 | $20 | - | - | - | - | - | - |
| 2 | $28 | $20 | $25 | - | - | - | - | - | - |
| 3 | $28 | $20 | $35 | - | - | - | - | - | - |
| 4 | $28 | $20 | $52 | - | - | - | - | - | - |
| 5 | $28 | $20 | $80 | - | - | - | - | - | - |
Step 1. Determine the cost structure for the firm. For a given total fixed costs and variable costs, calculate total cost, average variable cost, average total cost, and marginal cost. Follow the formulas given in the Cost and Industry Structure chapter. These calculations are shown in [link] .
| Q | P | TFC | TVC | TC
(TFC+TVC) |
AVC
(TVC/Q) |
ATC
(TC/Q) |
MC
(TC 2 −TC 1 )/ (Q 2 −Q 1 ) |
|---|---|---|---|---|---|---|---|
| 0 | $28 | $20 | $0 | $20+$0=$20 | - | - | - |
| 1 | $28 | $20 | $20 | $20+$20=$40 | $20/1=$20.00 | $40/1=$40.00 | ($40−$20)/
(1−0)= $20 |
| 2 | $28 | $20 | $25 | $20+$25=$45 | $25/2=$12.50 | $45/2=$22.50 | ($45−$40)/
(2−1)= $5 |
| 3 | $28 | $20 | $35 | $20+$35=$55 | $35/3=$11.67 | $55/3=$18.33 | ($55−$45)/
(3−2)= $10 |
| 4 | $28 | $20 | $52 | $20+$52=$72 | $52/4=$13.00 | $72/4=$18.00 | ($72−$55)/
(4−3)= $17 |
| 5 | $28 | $20 | $80 | $20+$80=$100 | $80/5=$16.00 | $100/5=$20.00 | ($100−$72)/
(5−4)= $28 |
Step 2. Determine the market price that the firm receives for its product. This should be given information, as the firm in perfect competition is a price taker. With the given price, calculate total revenue as equal to price multiplied by quantity for all output levels produced. In this example, the given price is $30. You can see that in the second column of [link] .
| Quantity | Price | Total Revenue (P × Q) |
|---|---|---|
| 0 | $28 | $28×0=$0 |
| 1 | $28 | $28×1=$28 |
| 2 | $28 | $28×2=$56 |
| 3 | $28 | $28×3=$84 |
| 4 | $28 | $28×4=$112 |
| 5 | $28 | $28×5=$140 |
Step 3. Calculate profits as total cost subtracted from total revenue, as shown in [link] .
| Quantity | Total Revenue | Total Cost | Profits (TR−TC) |
|---|---|---|---|
| 0 | $0 | $20 | $0−$20=−$20 |
| 1 | $28 | $40 | $28−$40=−$12 |
| 2 | $56 | $45 | $56−$45=$11 |
| 3 | $84 | $55 | $84−$55=$29 |
| 4 | $112 | $72 | $112−$72=$40 |
| 5 | $140 | $100 | $140−$100=$40 |
Step 4. To find the profit-maximizing output level, look at the Marginal Cost column (at every output level produced), as shown in [link] , and determine where it is equal to the market price. The output level where price equals the marginal cost is the output level that maximizes profits.
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