Long Run Entry and Exit Decision - Video Tutorials & Practice Problems
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If we cannot cover our costs in the long run, we should not be in this industry!
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Long Run Exit/Enter Decision
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Alright, So we've discussed the short run shut down. Now, let's talk about the long run exit from the market. Alright, So we're gonna see that a firm will exit the market if it cannot earn a profit. Right? If there's no way for it to make any money, there's no reason for it to be in business in this sector. Right? So it's gonna exit the market entirely if it cannot earn a profit, we're gonna say that it will enter a market if it can turn a profit. Right? So we're gonna see firms entering and exiting a market. Okay? So like before, just a recap, we're gonna say shuts down a firm shutting down. Well, that's a temporary right there, temporarily. Got it that time, temporarily, not gonna produce. Right? So that's a short run thing, they might produce again in the future if they shut down, but if they exit they're done, there's gonna produce no output forever, Right? This is the long run. If there's no way for them to make money in the long run, well then they're just gonna exit, they're not gonna have anything to do with this market. Okay, So when we're talking about a short run decision, well, we only considered the variable cost, right? Because those fixed costs, we're gonna remain fixed costs. Well, now, when we talk about a long run exit decision, well, now all costs are relevant, right, in the long run exit decision, um the relevant costs are all costs. Okay, So this includes the fixed costs and variable costs. Well, when I say fixed costs in the long run, there are no fixed costs. Right? That was our definition of the long run, it's enough time has passed that our fixed costs, we can change them, Right? So, if we had some sort of lease, right, that we were signed up to a lease and we had to rent this factory for so long, well, in the long run, that lease is gonna end, right? And we no longer have to rent this factory. So, all our costs in this long run, our variable cost. Right? So, those fixed costs from the short run, well, now we can change them, We can decide whether or not we want to keep them. Okay. Um So, what we're getting at here is that there are no fixed costs in the long run. Right? That's exactly the point here. All of our costs are variable costs and we can choose uh more thoroughly whether we want to produce in this market. Okay, So let's go ahead in the next video, we're going to do a similar example uh to what we did in the short run shutdown decision. Let's see what happens with the long run exit decision. Alright, let's do that in the next video.
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Long Run Exit/Enter Decision (continued)
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6m
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Alright, So now let's do a similar example, but now we're in the long run notice, how are our terminology has changed here A little bit. A farmer is considering if he should continue to rent a field for the upcoming season at a price of $1000. Right? So in this case he doesn't have the field rented already when we talked about the short run, he had already paid for the field and he was gonna have it no matter what, for the season. Right? So in this case He can decide whether or not he wants to pay for the field. Right? So the seeds still cost $200 here and we have to decide whether or not the farmers should produce. Right? So in the first case we see that revenues from sales are $500, just like last time. And we're gonna see what happens when revenues are $100 as well. Okay, so in this case, if they don't produce right before, when he didn't produce, he had to eat the cost of the field, right? That $1000 for the field, he had already paid it. There was nothing he could do about it. But now, in this case he hasn't paid for the field yet, right? He's deciding whether or not he wants to rent it. So if he doesn't produce, he doesn't have to pay for the field and he has zero profit, but zero loss as well right Now, what if he does decide to produce if he does decide he's gonna have to pay for the field, right? Well, first revenue, right? If he does produce, he's gonna bring in 500 in revenue. But now his total costs, he's gonna have to pay for the field, right? He's gonna have to pay the 1000 for the field And 200 for the seeds Total cost of 1200, right? This is similar to what we saw before and its profit Is gonna be that 500 - the 1200. And he's gonna lose $700 in this case. Right? So last time when we were talking about the short run, this was the better option, right? Because he was losing less money than if he paid for the field and didn't produce. But now he doesn't even have to pay for the field. So the best scenario in this case is no production, no loss, right? He's gonna have no loss, no profit either. But he's not gonna lose money. Right? This was a losing venture. He can finally get out and this is his chance to exit the market, right? What about if we have lower revenue? Well, you can imagine this is gonna be an even worse case, right? So if he doesn't produce again zero, right? He's not gonna have any profit or loss, he doesn't have to pay for the field, he doesn't have to pay for the seeds, he doesn't bring in any money as though he's got zero there. Now what if he does produce? Well his revenue will be the 100 from the sales and his total cost. Well he's gonna have to pay for the field 1000 he's gonna have to pay 200 for the seeds. So he's got 1200 in total cost there. His profit or his loss really is gonna be 100 minus 1200. Which is negative 1100. Right? Revenue minus cost their negative 1100. Okay so again his best case scenario is no production here. He shouldn't produce again and that is because he couldn't cover his costs. Right? So now notice what's happened is that all of our costs are relevant? Right? We were able to get out of paying for the field as well. So we're gonna see in this long run decision is that we're gonna shut down when the price falls below the minimum. And this time it's not the A. V. C. Right? In the short term it was the A. V. C. Only the variable costs but now its average total cost. Right? Because all the costs are relevant and we can get out of say renting the field in this case. Right? So they don't have a name for this like they did in in short run they had the shutdown point for that minimum point on the abc well they don't really have a name like that. It's the entry exit point right? Any point below that we are going to exit the market entirely. Okay. So this is a long run decision if our long run average total cost is uh greater than our price, right? We can't cover those costs in the long run, there's just no way for us to make money. So let's go ahead and finish up right now by doing similar to last time and defining defining this here. So we saw that we're gonna exit right? If our total revenues, the money we're bringing in can't cover our total costs in the long run, Right? So total revenue less than total costs. We're out of here, we exit. So let's do the same thing and divide right? Total revenue divided by Q. Right? We're gonna find the average of each and total cost divided by Q. And what was our average revenue just like last time? Right. Average revenue is just price. Like we discovered in our revenue video. So our left side of the equation becomes price and we're gonna exit if that price is less than our average total cost, right? And just here behind me, I'll move to the side, we're gonna enter the opposite, right? If the price is greater than average total cost, right? If that price is greater than average total cost, firms are going to see, hey, we can make money here, let's go ahead and join this market. We're gonna see the implications of this entering and exiting of the market in other videos. But for now, what we see is that for long run decisions, it's that average total cost curve. That matters again, right? So average variable cost curve doesn't matter for the long run decision. We want to see the average total cost. Okay, so let's go ahead and pause right here. And in the next video, let's discuss all of these uh these points on the graph. Alright, let's discuss what can happen at different price levels. Cool. Alright, let's do that now.
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Long Run Exit/Enter Decision on the Graph
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9m
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All right. So let's go ahead and see this long run exit decision on the graph. Alright, so we've got our cost curves, their marginal cost, average total cost and average variable cost. Right? And I want to want to set different price levels and see what's gonna happen in the short run the long run and what happens with profit as well. Okay, so let's start here with a high price, we'll call this one the one we're gonna go one through five. So let's start with a high price something way up here, the one somewhere along there. Okay, And remember that that price, that price level to the firm, that is the demand curve, right? They have to sell at that price set by the market and that is going to be their average revenue as well as their marginal revenue. Right? So that marginal revenue curve we just drew touches the marginal cost where our profit is maximized or loss is minimized right there. Right, That's the important point, marginal revenue equals marginal cost. So, let's ask a few questions. Should we produce in the short run at this price? Well, remember, in the short run we have to cover our average variable costs. And you can see that are price is greater than our average variable cost at that price. Right? The average variable costs are down their prices up there. So yes, we will produce in the short run because our price is greater than average variable cost and same thing with average total cost, right? The price is greater than average total cost right there. Um So we will produce in the long run as well. Okay so those are the conditions for short run production and long run production. Now what about whether we're gonna make a profit? So how do we see if we're gonna make a profit? Well that's if our price is greater than average total cost. Right? So this kind of goes with that long run decision which makes sense in the long run we're gonna exit the market if we can't make a profit. Right? So it's the same kind of idea. Is does our price cover our average total cost? And yes we just saw that with the long run production price is greater than average total cost. So don't draw this in cause I'm gonna erase it but this would be the profit right here. Right this box right here. Price minus average total cost times the quantity. Right? So let me just get that out of there. Um So we can continue to the next price level. Alright so yes we earn a profit there. Okay so let's go on to the next price level in this price. I want to touch the very minimum of the A. T. C. Curve. Okay so that's gonna be right, let me try that again a little bit. All right. Something like that. Right so it's a flat demand curve touching the very minimum of 80 c. So that is our marginal revenue curve. It touches marginal cost right here. So let's think about short run production first. So are we covering our average variable costs in this case? Yes we are. Right um Average variable costs are way down there are price level is above it. So yes in the short run we will produce, right. How about in the long run? Well in the long run our price is equal to our average total cost. Right? So in this case they are equal to each other. So it's not less, it's we're at that minimum point. And yes we are going to produce there right? Where price is equal to average total cost, it's not less than average total cost yet. Right? The average total cost isn't exceeding our price. So we're still gonna produce. However, if you notice since our price is touching our average total cost, we can't make a box there for our profit or our loss. Right? So here where price equals average total cost, Well there's no profit. Right? So at P. Two. Right? Um we have zero profit. Right? So they are going to produce but they're gonna have no profit. And you might say why are they even gonna bother producing and go through all this trouble? Well, you have to remember that when we're talking about economics, we talk about economic profit and when we defined economic profit, we discuss that economic profit um includes opportunity costs. Right? So some non monetary opportunity costs, things that you didn't have to spend money on. Um But they were still opportunity costs. So say like, you know, a foregone salary that the that the owner of the firm, instead of buying a farm and producing wheat, they could have been a chemical engineer and been making some money. Right? So these opportunity costs, they're not included in an accounting profit, Right? So when we think about an accounting profit, they are still making money in that sense. But the economic profit, when we consider these other opportunity costs, Well, that's when it goes to zero. Okay. So whenever we talk about profit in this class, you kind of, you have to remember that we're always talking about this economic profit and accounting profit is always gonna be a little higher. Right? So here we're we we have those opportunity costs as well being being accounted for. Okay, So let's go on to a third price level. Something in between average variable cost, an average total cost. So something like that. Okay. And what happens at this price level? So at p. three, what happens in the short run, shall we produce? Well, our marginal revenue touches our marginal cost right here and at that level we are above our abc, right? Were greater than a VC. So yes, we produce, let me go back to read, yes, we produce in the short run. What about in the long run, in the long run we can see that? Well, we're below 80 c. Right? And that was our condition for the long run our price has to cover average total costs and that's not happening here. Right. So in the long run we're not gonna produce. Okay. What about profit? Well profit has to do with price and average total cost. Right. So our profit in this case is negative. Right? We have a loss because our price is less than average total cost. Right? And we would end up having some sort of profit like well kind of like that box that's already there close enough to that. Okay So we are not gonna have a profit. We're gonna have a loss in this case. So I'm gonna put an end for no profit which really means a loss. Okay. Actually let me write loss because zero profit is also no profit. So I'm gonna put a loss in here. Okay so at the price of P. Three we've got a loss. Um let's go on to a price of P four. Okay? P. Four right here, I want to touch the minimum of the A. V. C. So something like this. Try one more time. There we go. So we're touching the minimum of the A. V. C. Curve. So our marginal revenue equals our marginal cost right here at the minimum of a VC. So what's gonna happen in this case? Well in the short run we are going to produce, right because we are covering our average variable cost. It's not below this is the minimum point where we're gonna produce? Remember this was called the shutdown point, the minimum of the A. V. C. So at p. four. Yes we will produce. Um But really the idea here because they're not gonna make any profit, they're not going to minimize their loss in any sense in this case. But why would they produce if they're not even gonna get any you know reduction of their loss or anything? Well really the firm is kind of almost indifferent about producing at this point. But we're gonna say that they do produce if they can produce they will. So yes they produce in the short run but in the long run right we're not covering those average total costs. Average total costs are way up there. So no we don't produce in the long run and we see that we have some sort of loss. Right? This this loss right here right? That's all gonna be loss all of that area. Cool. So I'll write loss in here again and let's go on to P five. Whoops. Let me erase that first and then write lost. Okay. Last but not least P. Five. And that's gonna be something sorry long run production was no right. We didn't cover our average total cost. So last one here we've got P five. I'm gonna pick something way down here. Right. And where would we produce in this case if we produced would be here right, on the upward part of the marginal cost. Um And what do we see here? Well, we're not covering our average variable cost. Right. So, no, we're not going to produce in the short run. In this case, we're below average variable cost, we're below average total cost and we've got a loss. Right? So there's never gonna be production in any of these cases, right. We're gone in the short run, gone in the long run at P5. Right, cool. So that's kind of how we're gonna deal with those long run exit decisions. Let's go ahead and move on to the next video.
