Question

Price MC ATC AVC - MR 40 45 47 Quantity a. (1 points) Using the graph above, what is the profit maximizing or loss minimizing output and price? b. (1 point)Using the graph above, what is the profit or loss for the profit maximizing firm? c. (2 points) What would happen in this market in the long run. Be sure to explain in detail what happens in the market and the firm. What would be the long run price, and output. d. (1 point) Explain why a firm may continue to produce in the short-run even though the producer is taking a loss. 3. (2 Points) How, if in the long run there is zero economic profit, do producers stay in business? (think about the difference between economic and accounting costs and the implications of this.)

Answer 1

2.

A.

It is a loss minimization case, because price is lower than the ATC in the given diagram.

So,

Loss minimizing output = 45

Price = 15

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B.

Profit = total revenue -total cost = 45*15 - 45*17

Profit = -90

So, the loss = 90

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C.

In the long run, the firms will exit as they will be making economic losses. It will cause a decrease in the market supply and market supply curve will shift to the left. It will increase the price when industry is considered. At the firm level also, MR curve will move upward direction and remain horizontal while being tangent to the ATC curve. It will make price to increase at the level where price = ATC = MC = MR. Now firms achieve zero economic profit and long run equilibrium is achieved.

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D.

Firm will produced in the short run even if it is earning negative economic profit, because firm is able to recover its variable cost and in the long run, when some firms exit, then the operating firm will get higher price to achieve zero economic profit. Further, firm operates, because it can change its capacity in the long run to produce at a level where P = ATC to achieve zero economic profit.  Hence, firms operate even if earning losses, but recovering the variable cost.

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