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Questions and Answers
What is the significance of the shutdown point for a perfectly competitive firm?
What is the significance of the shutdown point for a perfectly competitive firm?
- It is equal to the total cost curve of the firm.
- It represents the price above which the firm can cover all costs.
- It indicates the point of maximum profit.
- It is the price below which the firm should cease production. (correct)
What occurs at the output level where P = MR = AR?
What occurs at the output level where P = MR = AR?
- Normal profit
- Abnormal profit (correct)
- Sub-normal profit
- Maximum loss
When a firm experiences sub-normal profit, what costs are being covered?
When a firm experiences sub-normal profit, what costs are being covered?
- Average variable costs and part of fixed costs (correct)
- Total fixed costs only
- Average total costs only
- All costs including fixed and variable costs
In the short run, a firm maximizes profit when it produces at the level where:
In the short run, a firm maximizes profit when it produces at the level where:
What defines a normal profit situation in a competitive market?
What defines a normal profit situation in a competitive market?
What is the implication of P < AVC for a firm in the short run?
What is the implication of P < AVC for a firm in the short run?
What condition indicates that a firm is making a profit in the short-run?
What condition indicates that a firm is making a profit in the short-run?
What is the outcome for a firm when price is greater than average variable cost but less than average cost?
What is the outcome for a firm when price is greater than average variable cost but less than average cost?
At the equilibrium level of output for a perfect competitor, which condition must hold true?
At the equilibrium level of output for a perfect competitor, which condition must hold true?
In the short-run, if MC is below AC at the current output level, what can be inferred?
In the short-run, if MC is below AC at the current output level, what can be inferred?
What defines a 'normal profit' for a firm?
What defines a 'normal profit' for a firm?
If a firm’s average cost is lower than its price, what type of profit is the firm earning?
If a firm’s average cost is lower than its price, what type of profit is the firm earning?
What happens to a firm in the short run if the price falls below average variable cost?
What happens to a firm in the short run if the price falls below average variable cost?
Which condition represents the profit-maximizing level of output in a firm?
Which condition represents the profit-maximizing level of output in a firm?
What characterizes stage 2 of production in terms of Average Product and Marginal Product?
What characterizes stage 2 of production in terms of Average Product and Marginal Product?
At what point should a rational producer stop hiring additional labor?
At what point should a rational producer stop hiring additional labor?
If the value marginal product (VMP) of the 10th worker is less than $400, what does that indicate?
If the value marginal product (VMP) of the 10th worker is less than $400, what does that indicate?
What is the optimal level of labor input determined by?
What is the optimal level of labor input determined by?
What happens to Total Revenue if a firm continues to hire resources beyond the profit-maximizing level of output?
What happens to Total Revenue if a firm continues to hire resources beyond the profit-maximizing level of output?
Which situation denotes that a firm is incurring an economic loss?
Which situation denotes that a firm is incurring an economic loss?
What is indicated when the Marginal Product of Labor is negative?
What is indicated when the Marginal Product of Labor is negative?
Which of the following is true regarding total revenue and total cost?
Which of the following is true regarding total revenue and total cost?
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Study Notes
Profit and Loss in Perfect Competition
- The relationship P = MR = AR indicates that price, marginal revenue, and average revenue are equal for perfectly competitive firms.
- Abnormal profit occurs when price (P) exceeds average cost (AC), leading to supernormal profits.
- Sub-normal profit or loss occurs when price is below average cost but covers average variable cost (AVC) and part of fixed costs.
Shutdown Point
- The shutdown point is where price equals minimum average variable cost (AVC).
- If the price falls below AVC, it is more profitable for the firm to cease production rather than incur losses.
Short-Run Equilibrium Analysis
- In short-run equilibrium, MR = MC ensures that profits are maximized, and losses are minimized.
- Three situations arise concerning price and average cost:
- If P ≥ AC, the firm earns a profit.
- If AVC ≤ P < AC, the firm incurs acceptable losses.
- If AVC > P, the firm should shut down operations.
Types of Profit
- Normal profit is achieved when price equals average cost (P = AR = AC), indicating no economic profit.
- Supernormal profit occurs when price is greater than average cost (P = AR > AC), suggesting that a firm is earning excess profits.
Economic Stages of Production
- The production function has three stages:
- Stage 1: Increasing returns, both average product of labor (APL) and marginal product of labor (MPL) are rising.
- Stage 2: Diminishing returns, where APL and MPL are both falling but remain positive—this is the only economic stage.
- Stage 3: Diminishing returns continue, but MPL turns negative, indicating inefficiency.
Optimal Use of Labor
- Determining optimal input levels involves equating marginal benefit (Value Marginal Product, VMP) to marginal cost.
- The VMP measures the additional benefit in monetary terms gained from employing an additional unit of labor.
- Profitability hinges on hiring until VMP equals the cost of labor.
Example of Labor Hiring Decision
- Cost of an additional unit of labor: $400.
- VMP of the first labor unit: $228; thus, hiring is unviable based solely on this metric.
- VMP of the second unit: $516 indicates that hiring is profitable.
- For additional labor from the second to the ninth employee, VMP exceeds the hiring cost, justifying employment.
- However, the 10th labor unit has a VMP below $400, making it unprofitable to hire.
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