Question

In a perfectly competitive market, firms always operate at the lowest per-unit cost. Is the preceding statement true or false? Requirement 250 words or more

Answer 1

In a perfectly competitive market each firm fix its profit maximizing output at a level where it’s MC=MR or price equal to marginal cost. If the market price is higher than the ATC the firm will choose to produce a higher level of output by equating MC with MR and earns positive profit. .

If the market price is lower than the ATC the firm choose to produce a lower quantity at a point of equality between MC and MR. The purpose is to minimize loss. It is only in longrun the firms operate at the lowest point of the ATC.

In shortrun if the market price is higher than the ATC the existing firm will earn positive economic profit. This profit will attract new firms into the market. The entry of firm will increase the market supply and decrease the market price. Thus the existing firm reduces the volume of output by moving along the MC curve wherever its marginal cost equates price.

On the other if the if the existing price is lower than the ATC the existing firm incur loss. Thus in longrun the loss suffering firms will quit the industry and the exist of some of the firms will reduce the market supply and increase the market price. Thus the existing firms move up along the MC curve by producing more at a point where the MC equals price.

The free and exit of the firms moves the price to the lowest point of the ATC where all firms in longrun reach to breakeven or earns normal profit. Once the price is equals ATC in longrun there will be no tendency on the part of the firms to exit and enter. Thus only in longrun a firm under perfect competition operates at the lowest point of the average total cost.

The preceding statement is not true.