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In my textbook, it said (this is for SRAS and AD, but I'm also going to apply this a bit fo microeconomics.. sorry for mixing, but my question applies in both ways, I believe) "The average price level will need to increase too, from P1 to P2, to allow firms to cover the increased production costs associated with increased volumes of output"

enter image description here In my opinion, the price does not need to increase to make up for an "increased cost associated with increased quantity supplied/output"

  1. When I was doing some math regarding all of this I realized that for a firm to "cover its cost" (maintain the same amount of profit as before) it could actually lower prices and then maintain the same amount of profit (due to the increase in quantity counteracting my hypothesized lowering of prices)

Here is my math, which has allowed me to come to this conclusion: A firm sells 10 tomatoes for ¥10. Revenue is (¥10x10) = ¥100. Each tomato costs ¥5, so I do (¥5x10) to get ¥50 as a cost. Thus, profit is ¥100-¥50= ¥50. Farmer wants to maintain his profit of ¥50.... let's say now he increases his quantity supplied or output to 20 tomatoes. the cost is now (¥5x10)x2 = ¥100 (I did x2 cuz its 20 tomatoes now). For the farmer to maintain profit of ¥50 he prices the 20 tomatoes at ¥7.50 (less than previous price of ¥10), so that Revenue(¥7.50x20=¥150) and Cost(¥5x10x2=$100). Thus ¥150-¥100 is ¥50 for profit. profit maintained, but price was lowered to ¥7.50

I know I'm wrong, but I'm not able to understand the logic behind this. If anyone could help me with my specific questions or direct me to any online resources, that would be awesome. Thank you!

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this is for SRAS and AD, but I'm also going to apply this a bit fo microeconomics.. sorry for mixing, but my question applies in both ways, I believe

You are applying market equilibrium logic to the supply function. When aggregate demand shifts for some reason while the supply function is unchanged the equilibrium price will change.

If the short-run aggregate supply (SRAS) function is upward sloping then there are no economies of scale (in the short-run). This does not give you detailed information on what a firm is able to do long term.

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  • $\begingroup$ Some of my assumptions are wrong, but I am still confused why a price increase (from an AD shift right or microeconimically a Demand shift right) is necessary if the company can maintain profits without doing so and in fact lower prices. $\endgroup$
    – user27846
    Jul 10, 2020 at 7:12
  • $\begingroup$ @Rey "If the short-run aggregate supply (SRAS) function is upward sloping then there are no economies of scale (in the short-run)." Perhaps you have picked a cost function $C(y) = F + cy$ where there are economies of scale and thus the figure does not apply. If you wish, edit your numerical example into your question, but also include what SRAS looks like given your cost function and AD. $\endgroup$
    – Giskard
    Jul 10, 2020 at 7:16
  • $\begingroup$ I just mentioned the economies of scale out of the top of my mind. The math I am referring to is that "if for a firm to 'cover its cost' (maintain the same amount of profit as before) it could actually lower prices and then maintain the same amount of profit (due to the increase in quantity counteracting my hypothesized lowering of prices)". Please ignore my economies of scale talking-point. $\endgroup$
    – user27846
    Jul 10, 2020 at 7:26
  • $\begingroup$ @Rey "for a firm to 'cover its cost' (maintain the same amount of profit as before) it could actually lower prices and then maintain the same amount of profit" This is usually not the cause. Yes, if the firm lowers the price, the quantity demanded will grow, but why would it grow in just such a way that profits stay constant? Do you have numbers or a proof to back up this claim? $\endgroup$
    – Giskard
    Jul 10, 2020 at 8:46
  • $\begingroup$ @Rey As a side note: in models with supply curves firms are assumed to be price takers, they do not set their price. $\endgroup$
    – Giskard
    Jul 10, 2020 at 8:46

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