Changes

''Example Question'':  Suppose the price of a widget produced by a firm in perfect competition is less than the minimum average variable cost (AVC) in the market.  What will the firm do next in the short run?

''Example Question'':  Suppose the price of a widget produced by a firm in perfect competition is less than the minimum average variable cost (AVC) in the market.  What will the firm do next in the short run?

''Answer'':  Realize that the question is asking about the short run, so building a new factory or changing fixed costs is not possible.  There is not enough time.  Instead, the question is asking what can be done as a "quick fix" to the problem.  What is the problem?  The problem is that the price is LESS than the lowest average variable cost (AVC).  Now we know that that a firm is losing money when the price, or marginal revenue, is less than marginal cost.  A firm does not want to sell anything at less than marginal cost, because it loses money on it.   

''Answer'':  Realize that the question is asking about the short run, so building a new factory or changing fixed costs is not possible.  There is not enough time.  Instead, the question is asking what can be done as a "quick fix" to the problem.  What is the problem?  The problem is that the sales price is LESS than the lowest average variable cost (AVC).  A firm is losing money when the price, or marginal revenue, is less than marginal cost.  A firm does not want to sell anything at less than marginal cost, because it loses money on it.   

But how does marginal cost relate to AVC?  The relationship is tricky.  When Q=1, MC=AVC.  But that does not solve our problem above.  So let's read the question again carefully, which is so important in Economics.  The question says that the price (which is marginal revenue (MR)) is less than the MINIMUM AVC.  That means that MR is ALWAYS less than AVC, for all output Q.

But how does marginal cost relate to AVC?  The relationship is tricky.  When Q=1, MC=AVC.  But that does not solve our problem above.  So let's read the question again carefully, which is so important in Economics.  The question says that the price (which is marginal revenue (MR)) is less than the MINIMUM AVC.  That means that MR is ALWAYS less than AVC, for all output Q.

''Easy Question'': What is the firm's profit or loss when Q=0 in this problem?  This is an honors homework problem.

''Easy Question'': What is the firm's profit or loss when Q=0 in this problem?  This is an honors homework problem.

''Hard Question'': Prove mathematically that MC>MR for all Q>0 in this problem.  This is the most challenging honors homework problem this week.

''Hard Question'': Prove mathematically that MC>MR for all Q>0 in this problem.  This is the most challenging honors homework problem so far in this course.

== Obstacles to Reducing Costs ==

== Obstacles to Reducing Costs ==

1.  '''''In the short run''''', you have diminishing marginal productivity.  Additional employees are not likely to be as productive as your first employees, for example.  Diminishing marginal productivity results in higher average variable costs (AVC), because AVC = TVC/Q and your TVC (total variable costs) are increasing faster than your output Q when there is diminishing marginal productivity.

1.  '''''In the short run''''', you have diminishing marginal productivity.  Additional employees are not likely to be as productive as your first employees, for example.  Diminishing marginal productivity results in higher average variable costs (AVC), because AVC = TVC/Q and your TVC (total variable costs) are increasing faster than your output Q when there is diminishing marginal productivity.

2.  '''''In the long run''''', you may have decreasing returns to scale.  Note the difference between returns to scale, which is a "long run" concept, and marginal productivity, which is a "short run" issue.  In the long run, the bigger you become, the more difficult it is to manage all your "inputs" (workers and inventory and every supply and service you need to run your company).  Waste can easily get out of hand.

2.  '''''In the long run''''', you may have decreasing returns to scale.  Note the difference between returns to scale, which is a "long run" concept, and marginal productivity, which is a "short run" issue.  In the long run, the bigger you become, the more difficult it is to manage all your "inputs" (workers and inventory and every supply and service you need to run your company).  Waste can easily increase beyond expectations.

3.  '''''In the long run''''', your firm may also see rising prices for your inputs.  Your suppliers increase their prices periodically.  Inflation can hit you hard as the CPI increases from year to year.  Scarce resources may become even scarcer, unless you can find substitutes for them.

3.  '''''In the long run''''', your firm may also see rising prices for your inputs.  Your suppliers increase their prices periodically.  Inflation can hit you hard as the CPI increases from year to year. (Recall that the "CPI" is the "consumer price index," a measure of inflation.) Scarce resources may become even scarcer, unless you can find substitutes for them.

It's not easy to run a business, which is why 9 out of every 10 new businesses fail, and most success businesses eventually fail also.  But if you can control and reduce your costs, as Wal-Mart does, then you can succeed.

It's not easy to run a business, which is why 9 out of every 10 new businesses fail, and even most success businesses eventually fail also.  But if you can control and reduce your costs, as Wal-Mart does, then you can succeed.

== Gresham's Law ==

== Gresham's Law ==