Question

Draw the MC, MR, ATC, and long-run ATC curves for a perfectly competitive firm in long-run equilibrium. Explain the relationship between those curves. Next, draw another graph showing long-run equilibrium for the perfectly competitive market. What is the relationship between the two graphs?

Answer 1

The marginal cost us the extra cost incurred due to the sell of an extra unit of the product.

The marginal revenue is the extra revenue earned due to the sell of an extra unit of the product.

The average total cost is the average of the total cost incurred.

The long run ATC is shows the long run effect of the cost.

Since all the firms are profit maximisers, hence MC = MR . In a perfect competitive market marginal revenue us equal to the market price per unit of the output. Therefore, it's AR and MR curves are parallel to the X-axis.

In case of profit maximization, the MC should cut the MR from below. In the short run the price must be equal to or greater than the AVC or in the long run the price must be greater than or equal to LAC.

At the market price three conditions are fulfilled:

A) MC = MR

B) MC is upward sloping.

C) Price exceeds the minimum of SAVC(short run average cost)

At this market price the firm is producing profit maximizing output . In this case the supply curve is regarded as the upward sloping part of the SMC. If the price is lesser than SAVC then the firm cannot continue production as it won't be able to cover up it's variable cost and thereby incurred losses.

The long run equilibrium output refers to the situation when free and full adjustment in the capital equipment takes place. It is therefore long run average and marginal cost curve which are relevant for deciding about equilibrium output in the long run. In the long run it is the average total cost which is of determining importance since all costs are variable and none fixed.

With the price more than the average cost, more firms will enter the industry and vice versa. For long run equilibrium, Price = Marginal cost = Minimum average cost.

The first picture showing the relationship between the total revenue and the total cost curve. The second image showing the short run equilibrium and the third image representing the long run equilibrium.