Question

Assume at the firm's profit-maximizing level of output, q, is such that P = AVC(q). In this case, the firm will be:

a. earning economic profit = 0.

b. breaking even.

c. incurring an economic loss.

d. earning a positive economic profit.

Answer 1

Now, at a firm's profit maximizing level of output, the MR = MC, where Marginal Revenue = Average Revenue = Price, and MC = marginal cost,

So, here P = AVC = Average Variable Cost,

So, MC = Average Variable Cost, i.e. this is the point where the MC cuts the AVC curve, and by theory, we know MC cuts the AVC curve at its minimum. This is known as the shutdown point.

This is where the firm incurrs an economic loss.

Where the MC cuts the Average Cost i.e. AC curve, MC = AC, it is known as the breakeven point, this is where the firm incurrs zero economic profit,

And while moving from the intersection with the AC curve and the intersection of AVC curve, along the MC curve, i.e. between the break even level of output and the shutdown level, the firm incurs economic losses, but continues operation.

And at all price and output levels, where MC > AC, the firm incurrs positive economic profit.

So, here, the correct option is option c and the firm is incurring a loss.