Question

68.

Assume that the following conditions exist for a perfectly competitive firm:
price = $10, current output = 100 units/hour, ATC at current output = $9.00, AVC at current output = $8.00 and MC at current output = $8.00.
a. Is the firm earning any economic profit currently? How much is its profit or loss?
b. Is the firm maximizing its economic profit? How do you know? What should the firm do to maximize profit? Should it increase or decrease output?
c. Given your answers in part b, how will the market adjust to reach long-run equilibrium? What will happen to the economic profit in the long-run? Include appropriate graphs for the market and the typical firm in your explanation.

Answer 1

For a competitive firm, price = $10, current output = 100 units/hour, ATC at current output = $9.00, AVC

at current output = $8.00 and MC at current output = $8.00.

a. Firm is earning economic profit currently because price per unit is $10 and average cost is $9 per

unit which means for each unit there is a profit of $1 and for 100 units, profit earned is worth $100.

b. Firm is not maximizing its economic profit because its price is $10 per unit but its marginal cost is

$8. Since P > MC, firm can increase its output which would increase the MC till MC reaches P =

$10.  

c. In the long-run equilibrium no firm earns any economic profit. Since currently firms are earning

economic profits, new firms will enter in the long run that would increase the market supply and

reduce the price. This implies that all firms will then earn only normal profits.