Question

Answer the questions in detail

1. How the competitive firm makes its decisions on what price to charge for its product

2. How the competitive firm makes its decisions on what amount to produce

3. How the competitive firm makes its decisions on when to shut down in the short run.

Answer 1

Ans) Competitive market is where there are many sellers and many buyers. Sellers in this market sell homogeneous products. Both sellers and the buyers are price takers.

1) Since neither the indivisual seller nor the individual buyer is large enough to influence the market, price is decided by the forces of demand and supply. And that price is accepted by both buyers and sellers.

2) A profit maximising or loss minimising quantity for any firm is where the MR and MC curve intersect. Firm produces the quantity where MR and MC curve intersect.

3) If price is above ATC, firms earn positive economic profit. If price is equal to ATC, firms earn zero economic profit.

If price is below ATC, firms earn negative economic profit. But they do not shutdown immediately. They see whether the price is above or below AVC. If price is above AVC, firms will continue to operate in short run as they are able to recover their variable costs.

But if price is below AVC, firm will shutdown as it is unable to recover even the variable cost.