Question

. True or False, and explain (one sentence is sufficient)

A.) If P > ATC then a firms is making economic profit.

B.) In a perfectly competitive industry, it is possible for a firm to earn P > ATC in the long run.

C.) If P = AVC in the long run, then the firm should shut down and exit.

D.) If P < ATC in the short run, then a firm should shut down and exit.

E.) In a monopoly industry, it is possible for a firm to earn P > ATC in the long run.

I am unsure what reference that the expert is referring too. This is a Microeconomics question. Please let me know if there is any additional information that is needed.

Answer 1

A) TRUE.

If P> ATC, it means that the price charged is more than average total cost. It implies that the price charged is able to cover all the costs and also generate a revenue after covering all the costs. Hence, a profit is generated after covering all the costs. Hence, TRUE.

B) FALSE

A perfectly competitive firm does not earn economic profits in the long run due to free entry and exit. A perfectly competitive firm earns normal profits only in the long run ( P=ATC). If existing firms are earning economic profits, then new firms will get attracted to enter the industry to earn these economic profits. As new firms will enter, the Supply of the industry will increase and Supply curve of the industry will shift to the right. This rightward shift of the Supply curve with an unchanged demand curve will cause the equilibrium price to fall. As price will fall, profits will also fall. This entry of new firms will continue to take place until increased supply has reduced the price to such a level that all the firms earn normal Profits only i.e., P= ATC ( just covering their costs) in the long run. If existing firms are incurring losses, then few firms will exit the industry in the long run. As firms will exit, the Supply of the industry will decrease and Supply curve will shift to the left. This leftward shift of the Supply curve with an unchanged demand curve will cause the equilibrium price to rise. As price will rise, losses will be eliminated. This process of exit of firms will continue to take place until reduced supply has increased the price to such a level that all the firms earn normal Profits only( P= ATC) in the long run. Hence, it is not possible for a perfectly competitive firm to earn P> ATC in the long run.

C) TRUE.

If P= AVC in the long run, then the firm should shut down and exit. Long run is the time period during which all the factors of production can be changed .If the firm is incurring losses even in the long run, then the firm should shut down and exit and take up another profitable production.

D) FALSE

A firm should shut down in the short run when price is less than average variable cost ( P < AVC).

A firm has to decide whether to produce or shut down in the short run . If the firm produces nothing, losses are equal to fixed costs. If price is less than average variable cost, then losses in case of producing are fixed costs plus variable costs. Hence, losses in case of producing when price is less than average variable cost ( fixed costs plus variable cost) are more than losses in case of shut down ( fixed costs) . Hence, the firm decides to shut down .

If P < ATC , the firm can continue to operate in the short run.

E) TRUE

A monopoly firm can earn P > ATC ( economic profits) in the long run. This is because a monopoly is characterised by high barriers to entry. As such, no new firms enter the industry in the long run and the Monopoly firm can earn economic profits ( P > ATC) in the long run.