Answer to Question #306030 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)

It is true that in a perfectly competitive market, the marginal cost curve of a firm in this market is the firm's supply curve above the minimum average variable cost curve. This is the case because for a firm to make a decision on the quantity it will produce, it needs to look at its market price first. On the supply curve, it is the point where the market price is equal to its marginal cost so as to make profits. P = MC, a firm is making profits by making sure that its price is above its minimum average variable cost meaning that it marginal cost curve portion that lies above it minimum point of its average variable cost curve is its supply curve.

b)

The shutdown rule states that in the short run a firm should continue to operate if the price exceeds average variable costs. If a firm is operating at a loss shown by less revenue compared to the total cost, the firm must decide to operate or temporarily shut down.