Google
Thursday 
October 30, 2014 

AmosWEB means Economics with a Touch of Whimsy!

AmosWEBWEB*pediaGLOSS*aramaECON*worldCLASS*portalQUIZ*tasticPED GuideXtra CrediteTutorA*PLS
Today's Index
Yesterday's Index
277.4

Help us compile the AmosWEB Free Lunch Index. Tell us about your last lunch.

Skipped lunch altogether.
Bought by another.
Ate lunch at home.
Brought lunch from home.
Fast food drive through.
Fast food dine in.
All-you-can eat buffet.
Casual dining with tip.
Fancy upscale with tip.

More About the Index


AGGREGATE MARKET SHOCKS: Disruptions of the equilibrium in the aggregate market (or AS-AD model) caused by shifts of the aggregate demand, short-run aggregate supply, or long-run aggregate supply curves. Shocks of the aggregate market are associated with, and thus used to analyze, assorted macroeconomic phenomena such as business cycles, unemployment, inflation, stabilization policies, and economic growth. The specific analysis of aggregate market shocks identifies changes in the price level (GDP price deflator) and real production (real GDP). However, changes in the price level and real production have direct implications for the unemployment rate, the inflation rate, national income, and a host of other macroeconomic measures.

Visit the GLOSS*arama


PERFECT COMPETITION, LOSS MINIMIZATION:

A perfectly competitive firm is presumed to produce the quantity of output that minimizes economic losses, if price is greater than average variable cost but less than average total cost. This is one of three short-run production alternatives facing a firm. The other two are profit maximization (if price exceeds average total cost) and shutdown (if price is less than average variable cost).
A perfectly competitive firm guided by the pursuit of profit is inclined to produce the quantity of output that equates marginal revenue and marginal cost in the short run, even if it is incurring an economic loss. The key to this loss minimization production decision is a comparison of the loss incurred from producing with the loss incurred from not producing. If price exceeds average variable cost, then the firm incurs a smaller loss by producing than by not producing.

One of Three Alternatives

Production Alternatives
Price and CostResult
P > ATCProfit Maximization
ATC > P > AVCLoss Minimization
P < AVCShutdown
Loss minimization is one of three short-run production alternatives facing a perfectly competitive firm. All three are displayed in the table to the right. The other two are profit maximization and shutdown.
  • With profit maximization, price exceeds average total cost at the quantity that equates marginal revenue and marginal cost. In this case, the firm generates an economic profit.

  • With shutdown, price is less than average variable cost at the quantity that equates marginal revenue and marginal cost. In this case, the firm incurs a smaller loss by producing no output and incurring a loss equal to total fixed cost.

Zucchini Production

The marginal approach to analyzing a perfectly competitive firm's short-run production decision can be used to identify the economic loss alternative. The exhibit displayed here illustrates the short-run production decision by Phil the perfectly competitive zucchini grower.

Incurring a Loss
Incurring a Loss
The three U-shaped cost curves used in this analysis provide all of the information needed on the cost side of the firm's decision. The demand curve facing the firm (which is also the firm's average revenue and marginal revenue curves) provides all of he information needed on the revenue side.

For the time being, Phil faces a $4 price for his zucchinis. As such he produces 7 pounds of zucchinis, which equates the $4 marginal revenue with marginal cost. However, should this price decline, say to $2.60 per pound, then maximizing a positive profit is not his primary concern. His decision turns to minimizing losses. Click the [$2.60] button to illustrate the situation facing Phil with a lower price.

The key to this lower price is that it intersects the marginal cost curve between the average total cost curve and the average variable cost curve. This is crucial. It means that Phil does not generate enough revenue per pound of zucchinis sold (average revenue = $2.60) to cover the cost of producing each pound of zucchinis (average total cost = $3).

Phil clearly incurs an economic loss on each pound of zucchinis produced and sold. In fact, if Phil produces 6.25 pounds of zucchinis (the quantity that equates marginal revenue and marginal cost), then his total cost is $18.75, but his total revenue is only $16.25. He incurs an economic loss of $2.50, a loss of $0.40 per pound produced.

The Short-Run Choice

Perhaps Phil should stop producing. Perhaps he would be better off by NOT selling zucchinis. Unfortunately, Phil is faced with short-run fixed cost. Phil incurs a total fixed cost of $3 whether or not he engages in any short-run production. Even if he shuts down production, he still must pay this $3 of fixed cost.

As such, Phil is faced with a comparison between the loss incurred from producing with the loss incurred from not producing. Those are his two short-run choices. If he produces, he incurs a loss of $2.50. If he does not produce, he incurs a loss of $3.

The choice seems relatively obvious: Phil is better to produce 6.25 pounds of zucchinis, incurring an economic loss of $2.50, and hoping for an increase in the price.

Phil continues to produce in the short run because he generates enough revenue to pay ALL of his variable cost, plus a portion of his fixed cost. By producing 6.25 pounds of zucchinis, he generates $16.25 of total revenue. While this revenue falls short of covering the $18.75 of total cost entirely, it is enough to pay the $15.75 of total variable cost, with an extra $0.50 left over to pay a portion of the $3 total fixed cost. This is why the economic loss from production is less than total fixed cost.

Because Phil has no market control, he is subject to the whims of the market price. This $2.60 zucchini price generates sufficient total revenue for Phil to pay ALL variable cost and some fixed cost. However, should this market price drop, then Phil would have to reevaluate his production decision. If the price declines enough, Phil will be forced to shut down production in the short run.

<= PERFECT COMPETITION, LONG-RUN PRODUCTION ANALYSISPERFECT COMPETITION, MARGINAL ANALYSIS =>


Recommended Citation:

PERFECT COMPETITION, LOSS MINIMIZATION, AmosWEB Encyclonomic WEB*pedia, http://www.AmosWEB.com, AmosWEB LLC, 2000-2014. [Accessed: October 30, 2014].


Check Out These Related Terms...

     | perfect competition, profit maximization | perfect competition, shutdown | perfect competition, short-run supply curve | short-run production alternatives | breakeven output |


Or For A Little Background...

     | loss minimization rule | shutdown rule | profit maximization | average total cost curve | average revenue curve | profit | economic profit | perfect competition | perfect competition, characteristics | U-shaped cost curves | profit maximization |


And For Further Study...

     | perfect competition, demand | perfect competition, short-run production analysis | perfect competition, long-run production analysis | perfect competition, efficiency | perfect competition, total analysis | perfect competition, marginal analysis | perfect competition, profit analysis | long run industry supply curve |


Search Again?

Back to the WEB*pedia


APLS

State of the ECONOMY

New Orders for Manufactured Durable Goods
August 2014
$245.4 billion U.S. Commerce Dept.
Down 18.2% from July 2014

More Stats

BROWN PRAGMATOX
[What's This?]

Today, you are likely to spend a great deal of time strolling through a department store seeking to buy either a coffee cup commemorating the 2000 Olympics or a birthday gift for your grandmother. Be on the lookout for empty parking spaces that appear to be near the entrance to a store.
Your Complete Scope

This isn't me! What am I?

Approximately three-fourths of the U.S. paper currency in circular contains traces of cocaine.
"He who truly knows has no occasion to shout. "

-- Leonardo da Vinci, painter, sculptor, architect, engineer

JF
Journal of Finance
A PEDestrian's Guide
Xtra Credit
Tell us what you think about AmosWEB. Like what you see? Have suggestions for improvements? Let us know. Click the User Feedback link.

User Feedback



| AmosWEB | WEB*pedia | GLOSS*arama | ECON*world | CLASS*portal | QUIZ*tastic | PED Guide | Xtra Credit | eTutor | A*PLS |
| About Us | Terms of Use | Privacy Statement |

Thanks for visiting AmosWEB
Copyright ©2000-2014 AmosWEB*LLC
Send comments or questions to: WebMaster