Question

6. (10 points) Draw a graph showing the short-run average total, average variable, and marginal cost curves for a typical firm. Draw in three prices that result in the firm making positive profits, breaking even, and making negative profits that are less than fixed costs.

Answer 1

SMC S円 Price p Cast El Po PFC

In the figure x axis shows the output and y axis shows price and cost.SAC is the average total cost and AVC is average variable cost and SMC is the short run marginal cost curve of a perfectly competitive firm .(AFC is the short run fixed cost curve.)

At P1 price equilibrium point is E1 where marginal cost is equal to price or marginal revenue and average revenue is equal to average cost.(Price= AR=MR.It is a perfectly competitive firm condition).At the equilibrium point E1 SMC cuts the minimum point of SAC and the firm is at the break even point because the firm covers all the costs. Break even point is a point where the firm covers its costs and AR=AC.No profit no loss.

At point P2 equilibrium point is E2 and the firm is making positive profit since AR or average revenue or price is greater than Short run average cost.That is ,price is more than average cost and firm makes profit.

At P3 firm is making negative profits as the price is less than variable cost and the fixed cost .

*(At P0 the firm covers only variable cost since Price =AVC.It is the shut down point.)

S MC P 2 E! Price Po P3 Output