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Chapter 8: Problem 19

How does the average cost curve help to show whether a firm is making profits or losses?

Short Answer

Expert verified
The average cost curve represents the per-unit cost of producing a specific quantity of output. Profits occur when a firm's average revenue (market price) is higher than its average cost, and losses occur when average revenue is lower than average cost. To determine if a firm is making profits or losses, compare the average cost curve with the market price. If the market price is higher than the average cost at the production point, the firm is making a profit. If the market price is lower than the average cost at the production point, the firm is making a loss. The breakeven point is where the firm's average revenue equals its average cost, indicating neither profit nor loss.

Step by step solution

01

Understand the Average Cost Curve

The average cost curve represents the per-unit cost of producing a certain quantity of output. It is the total cost of production divided by the total number of units produced. The average cost curve is usually U-shaped because of economies of scale and diseconomies of scale. When a firm produces goods and services at a lower average cost, it can sell those goods and services at a lower price, making it more competitive in the market.
02

Identify Profit and Loss Situations

Profits occur when the firm's total revenue is greater than its total costs, while losses occur when the firm's total revenue is less than its total costs. This can also be understood at the per-unit level. If a firm's average revenue (or market price) is higher than its average cost, the firm is making profits. If the average revenue is less than the average cost, the firm is making losses.
03

Compare Average Cost Curve with Market Price

In order to use the average cost curve to determine if a firm is making profits or losses, we need to compare the average cost curve with the level of market price (which equals the average revenue of the goods produced). If the market price is higher than the average cost at the point where the firm is producing, the firm is making a profit. If the market price is lower than the average cost at the point where the firm is producing, the firm is making a loss.
04

Determine Breakeven Point

The breakeven point is the level of output where a firm's total revenue is equal to its total cost, or where its average revenue is equal to its average cost. At this point, the firm is neither making a profit nor a loss. When the average cost curve is compared to the market price, and they intersect at a point, that is the level of output where the firm breaks even.

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Most popular questions from this chapter

Do entry and exit occur in the short run, the long run, both, or neither?

Will a perfectly competitive market display allocative efficiency? Why or why not?

A computer company produces affordable, easy-to-use home computer systems and has fixed costs of \$250. The marginal cost of producing computers is \(\$ 700\) for the first computer, \(\$ 250\) for the second, \(\$ 300\) for the third, \(\$ 350\) for the fourth, \(\$ 400\) for the fifth, \(\$ 450\) for the sixth, and \(\$ 500\) for the seventh. a. Create a table that shows the company's output, total cost, marginal cost, average cost, variable cost, and average variable cost. b. At what price is the zero-profit point? At what price is the shutdown point? c. If the company sells the computers for \(\$ 500,\) is it making a profit or a loss? How big is the profit or loss? Sketch a graph with \(\mathrm{AC}, \mathrm{MC},\) and \(\mathrm{AVC}\) curves to illustrate your answer and show the profit or loss. d. If the firm sells the computers for \(\$ 300,\) is it making a profit or a loss? How big is the profit or loss? Sketch a graph with AC, MC, and AVC curves to illustrate your answer and show the profit or loss.

Explain in words why a profit-maximizing firm will not choose to produce at a quantity where marginal cost exceeds marginal revenue.

Since a perfectly competitive firm can sell as much as it wishes at the market price, why can the firm not simply increase its profits by selling an extremely high quantity?
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