Question

what is relationship between total revenue and cost if the price is greater than ATC ( is TR greater, less, or equal to TC)? Dies the firm make positive economic profit or loss?

Answer 1

Average total cost, when combined with price, determines per unit profit or loss that a profit-maximizing firm receives from short-run production.

• If price is greater than average total cost, then the firm receives positive economic profit per unit. This means that Total Revenue is greater than Total Cost. Positive Economic Profit= Total Revenue - Total Cost
• If price is less than average total cost, the firm incurs a loss, or negative economic profit, per unit. This means that Total Revenue is less than Total Cost.
• If price is equal to average total cost, then the firm is just breaking even, receiving neither a per unit profit nor incurring a per unit loss. This meabs that Total Revenue is equal to Total Cost.

The key feature of this average total cost is the shape. It is U-shaped, meaning it has a negative slope for small quantities of output, reaches a minimum value, then has a positive slope for larger quantities. This U-shape is indirectly attributable to the law of diminishing marginal returns.

When ATC is compared with price it indicates price per unit profitability of profit maximizing firm.

Average Total Cost = Total Cost / Quantity of Output

It can also be computed in following way:

Average Total Cost = Average Fixed Cost + Average Variable Cost.