Answer to Question #235414 in Microeconomics for anika

Question

 Represent the information below in an appropriately labelled diagram and decide whether the firm  should continue production or shut down in the short run. 

The loss-minimizing quantity is 100 mugs. The average variable cost (AVC) is 9 taka per mug and  the average fixed cost (AFC) is 4 taka per mug. The firm charges a price of 12 taka per mug. 

Answer 1

 A perfectly competitive firm is where there are many sellers selling homogeneous products. A profit maximizing firm produces the quantity where MR and MC curve intersect.

If price is more than ATC then firm will earn positive economic profit in short run and more firms will enter into the market. This will increase supply and decrease price. Price will decrease Till it reaches minimum of ATC where firms will earn zero economic profit.

If price is below ATC but above AVC firm will earn negative economic profit but will produce in short run as this will minimize loss. If conditions do not get better some firms will exit the market. This will decrease supply and increase price. Price will increase till it reaches minimum of ATC where firms will earn zero economic profit.

Thus we see that a perfectly competitive firm always earn zero economic profit in long run and price is equal to minimum of ATC.

If price is below AVC then firm will shutdown.

1) Firm will produce in short run as price is below ATC but above AVC. This will help the firm minimize the loss because it will be able to cover all its variable cost and some of its fixed costs (total cost = variable costs + fixed cost).