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Firms' Short-Run Decisions to Produce and Long-Run Decisions to Enter or Exit a Market

Paul Scott

Paul Scott

9 min read

Study Guide Overview

This study guide covers perfectly competitive markets, focusing on firm entry and exit. Key concepts include the shutdown rule (P < AVC), short-run vs. long-run decision-making, impacts of profit and loss on market supply, and achieving long-run equilibrium (zero economic profit). It also provides practice questions with graph analysis and scenario application.

AP Microeconomics: Market Entry & Exit - Your Night-Before Guide

Hey! Let's get you prepped for the exam with a super focused review of market entry and exit. We'll break down the key concepts, look at some graphs, and make sure you're feeling confident. Let's do this! 💪

Perfectly Competitive Markets: The Basics

Key Concept
  • Many Sellers: Lots of firms are competing.
    • Low Barriers to Entry/Exit: Easy for firms to start or stop production.
    • Price Takers: Firms accept the market price; they don't set it.

Entering vs. Exiting

  • Entering: A firm starts producing and selling goods (quantity > 0).
  • Exiting: A firm stops producing, but might still exist as a company (quantity = 0).

The Shut-Down Rule: Short-Run Decisions

When to Shut Down

  • In the short run, firms have fixed costs they must pay regardless of production.
  • Firms compare Total Revenue (TR) to Total Variable Cost (TVC) or Price (P) to Average Variable Cost (AVC).
Key Concept

Shutdown Rule: If P < AVC, the firm should shut down and only pay fixed costs.

Memory Aid
  • Think: "If you can't cover your variable costs, don't produce! Just pay the fixed costs."

Visualizing the Shutdown Point

  • Below, the firm should shut down because the price (5) is less than the AVC (7) at the profit-maximizing quantity (10).

Shutdown Rule Graph

  • Caption: The firm will shut down at a quantity of 10 because the price (5) is less than the average variable cost (7).

Example

  • TR = 50 (10 units x 5/unit)
  • TC = 120 (10 units x 12/unit)
  • Loss if operating = 70 (50 - $120)
  • Fixed Cost (FC)= 50 (AFC of 5 x 10 units). Remember, AFC is the vertical distance between ATC and AVC.
  • Decision: Shut down because 50 (fixed cost) < 70 (loss if operating).
Quick Fact
  • Producer Surplus (PS) = TR - TVC. If P < AVC, PS is negative, which is another way to see why firms shut down.

Long-Run Entry and Exit

Long-Run Decisions

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Question 1 of 11

Which of the following is a key characteristic of a perfectly competitive market? 🤔

A single seller dominates the market

High barriers to entry and exit

Firms are price setters

Many sellers competing in the market