Suppose that firm j is perfectly competitive. Case 1) If the market price P_{mkt} is greater than the minimum of firm j's average total cost (ATC) curve, then firm j maximizes its short run (SR) profits at the output level, denoted Q_{j}*, that satisfies the condition: marginal revenue equals marginal cost (MR = MC). In this case, firm j's SR profits at Q_{j}* are positive and equal to [Pmkt - ATC(Q_{j}*)] x Q_{j}* > 0, where ATC(Q_{j}*) denotes average total cost at Q_{j}*. Note that if P_{mkt} equals the minimum of the ATC curve (P_{mkt} = ATC(Q_{j}*)), then firm j's SR profits at Q_{j}* are zero and firm j is said to be at its SR break-even point. Case 2) If the market price P_{mkt} is between the minimum of the average variable cost (AVC) curve and the minimum of the ATC curve (i.e., min AVC < P_{mkt} < min ATC), then a firm j maximizes its SR profits (i.e., minimizes its loss) at the output level Q_{j}* that satisfies the condidtion MR = MC. In this case, firm j's SR profits at Q_{j}* are negative but its loss at Q_{j}* is less than its loss if firm j were to shut down and produce zero output, the latter of which would be equal to its total fixed costs, TFC. That is, -TFC < j's SR profits at Q_{j}* = [P_{mkt} - ATC(Q_{j}*)] x Q_{j}* < 0. Case 3) If the market price P_{mkt} equals the minimum of the AVC curve, then firm j maximizes its SR profits (i.e., minimizes its loss) either at the output level Q_{j}* that satisfies the condition MR = MC or at 0 (zero) output. In this case, firm j's SR profits at either Q_{j}* or 0 are negative and equal to -TFC and firm j is said to be at its SR shutdowm point. That is, j's SR profits at either Q_{j}* or 0 output = -TFC.Case 4) If the market price P_{mkt} is less than the minimum of the AVC curve, then firm j maximizes its SR profits (i.e., minimizes its SR losses), at 0 (zero) output. If Q_{j}' is the quantity that satisfies MR = MC, then j's SR loss at Q_{j}'is greater than its SR loss at 0 output, which is equal to -TFC. Thus, the loss (negative profits) are minimized at 0 instead of at the quantity where MR = MC.That is, j's SR profits at Q_{j}' < j's SR profits at 0 output = -TFC < 0. |
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