Question

5. Comment critically and support your answer with a numerical example: “even in the short run, a purely competitive firm would not operate if losses incur."

6. Explain what happens, in the long-run, to economic profits of a firm operating in a purely competitive environment. Profits of a Monopolist in the long-run?

Answer 1

Due to presence of HOMEWORKLIB POLICY, I am answering one question.

5.

Ans:

When price goes below minimum of AVC, even normal profits do not occur. Operating losses occur and firm shuts down. Firm can work even if price covers some of fixed costs (normal profit). In this case when P < min(AVC), even variable costs do not get covered.

Numerical example:

Suppose firm's:

TC = 10 + 5Q

AC = 10/Q + 5

AVC = 5 = MC

When price is above 5, variable costs get covered which implies there is operational profit in short run when scale is fixed.

When price is below 5, even variable costs do no get covered implying operational loss. Then firm must shut down.

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