Compare and contrast the way in which an individual firm and the industry determine there short run and long run outputs under perfect competition.
(TR >TC). Profits will be maximized where marginal cost equals marginal revenue, this occurs at output 9. Whilst MR is greater than MC total revenue is increasing at a faster rate than total cost, thus profits will be increasing. After output 9 where marginal cost is greater than marginal revenue, total cost is increasing more quickly than total revenue and therefore profits are declining.
Profit - at the profit maximizing output average cost (which includes normal profit) is below average revenue and therefore the firm is making supernormal profits equal to the shaded area in the diagram.
The firm's short run supply curve will be its (short run) marginal cost curve. A supply curve relates quantity to marginal cost.
Long Run Equilibrium of the Firm
In the long run if typical firms are making economic profits, new firms will be attracted into the industry or existing firms will increase the scale of their operations. The industry supply curve will shift to the right, leading to a fall in price. Supply will go on increasing and price falling until firms are only making normal profits. This will be where the demand curve for the firm touches the lowest point of its average cost curve. This can be seen in the diagram below.
In the long run if the price falls below the average cost of producing the good (P2), then firms will make a loss and will leave the industry. If firms leave the industry supply will decrease and the price will rise until firms are just making normal profit - that is where the demand curve touches the lowest point of the average cost curve. Therefore under perfect competition output will always tend towards this long run equilibrium.
Long run equilibrium is therefore where AR = MR = MC = AC
Shut Down Point
We can find the short run break even price and the short run shut down price by comparing the price with average variable total costs. Profit maximization occurs where MC=MR. Since the average total costs (ATC) includes all the relevant opportunity costs, this equilibrium is the short run break even point where normal profits (zero economic profits are being made). As the price falls the firm will carry on producing but be making below normal profit. However, if the price falls below the average variable costs then it will not be worth the firm producing any longer as they will be making a loss larger than their fixed costs. The shut down point therefore comes when average revenue is equal to average variable cost.