Question

Use a graph to demonstrate the circumstances that would prevail in a competitive market where firms are earning economic profits. At its current level of production a profit-maximizing firm in a competitive market receives $12.50 for each unit it produces, and faces an average total cost of $10. At the market price of $12.50 per unit, the firm's marginal cost curve crosses the marginal revenue curve at an output level of 1000 units. What is the firm's current profit? Can this profit be maintained in the long run? Carefully explain your answer.

Answer 1

4. Ans:

The profit maximization condition under perfect competition is where price equals marginal cost ( P = MC).

As per given information , at market price $12.50 the profit maximizing level of output is 1000.

So the total revenue = Price * Quantity = $12.50 *1000=$12500

Total cost = ATC * Quantity = $10 * 1000 = $10000

Firm's current profit = Total revenue - Total cost = $12500 - $10000 = $2500

This profit can not be maintained in the long run because other firm will enter in to the market . As a result the firm will earn normal profits in the long run.

The following graph shows the firm's profit maximizing level of production with economic profits.

Following graph shows normal profits of firm in the long run ;