Neatly draw and label both the market and representative firm graph for a firm in a...

Neatly draw and label both the market and representative firm graph for a firm in a perfect competition which is earning an economic loss in the short run and should choose to operate at a loss. What is going to happen in the long run? How will this affect the graph?

Solutions

Expert Solution

Ans) In Perfectly competitive market, price is equal to marginal revenue for individual firm.

A profit maximising firm produces the quantity where MR and MC curve intersect.

If price is above ATC, firms earn positive economic profit.

If price is below ATC, firms earn negative economic profit.

When price is below ATC, firms see whether the price is above or below AVC. Firm will continue to operate only if the price is above AVC.

When firms operate at loss i.e below ATC but above AVC, some firms will exit the market in long run. As a result, supply will decrease and price will increase. Price will increase till it reaches minimum of ATC where firms earn zero economic profit. (Perfectly competitive firm always earn zero economic profit in long run.)

Above graph shows that firm is operating at loss.

Above graph shows that as some firms exit the market, supply decreases and price increases and firm is earning zero economic profit in long run.

Rahul Sunny answered 1 week ago

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