Question

МС ATC AVC 22 16 MR 12 11 17 19 14 Quantity (units) What is the shutdown price? What will the firm choose to do in the short-run? Explain why this is the best decision for the firm Explain how the entry or exit will occur in the market to ensure that firms earn zero economic profit in the long run? Clearly label the firm's supply curve. Price (dollars per unit)

Answer 1

The MC cost curve above the AVC cost curve is the SUPPLY curve of the firm ATC Price (dollars per unit) Supply Curve (AVC MR th 14 17 19 Quantity (units) What is the shutdown price? The shut down point will be at price $11. Shut down point is there where the price is equal to minimum of average variable cost. Any price below this, the firm will shut down. What will the firm choose to do in the short-run? Explain why this is the best decision for the firm. In the above diagram, the price is $16. The equilibrium condition is MR=MC. At this point the output level is 17. At this point the ATC is $23 which more than the AR or price. This implies that the firm is getting a loss. However, the AVC at this output is $12, that is below the price. This means the firm is recovering all variable cost and some of the fixed cost. In this condition the firm should choose to continue production. In this condition if the firm chooses to shut down, then the entire FC will be a loss and that will be larger than the present loss. Therefore, it is the best decision to continue production. Explain how the entry or exit will occur in the market to ensure that firms earn zero economic profit in the long run? If the same condition prevails in the long run, because of losses some of the firms will exit the market. When some firms exit the market, the volume of output or supply decreases. When supply decreases the price of commodity increases and ultimately it becomes equal to the AR (price) at one output level. When the AR=AC, the firms will get only normal profit. In the long run all the firms gets only normal profit to stop the entry and exit of firms from the industry. Clearly label the firm's supply curve. Firm's supply curve will be the MC curve above the AVC cost curve.