Answer to Question #306027 in Microeconomics for katrichie

Question

a) Use a diagram discuss and explain why marginal cost above its minimum average variable cost is called supply curve. (6)

b) Explain competitive firm short –run shutdown decision rule. (4)

Answer 1

A) From the diagram below, a fall in price will cause producers to produce decreasing quantity of production. This is because at each falling price, which is still above the average variable cost (AVC), the firm can cover all it's fixed cost even when it's making a loss. If however, price falls below the AVC, nothing will be produced as more losses will be added to the losses made already, i.e. the fixed cost. This implies the producers behavior that at prices which are able to cover their AVC, they'd keep producing.

The shaded portion of the MC curve which is above the AVC curve represents the supply curve of the firm

B) A competitive firm's shutdown decision rule occurs when the firm can no longer cover it's average variable cost. This comes as a result of them adding to their already increasing cost, the cost if each extra unit of output produced.