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 helps determine whether a firm is making profits or losses by comparing the average total cost (ATC) to the market price (P) at the profit-maximizing level of output, where marginal cost (MC) equals marginal revenue (MR). If ATC < P, the firm is making a profit. If ATC > P, the firm is making a loss. If ATC = P, the firm is breaking even without profit or loss. The difference between ATC and P indicates the profit or loss per unit sold.

Step by step solution

The average cost curve represents the average cost of production at various levels of output. It is the division of a firm's total cost by the quantity produced. The average cost curve consists of three parts: average fixed cost (AFC), average variable cost (AVC), and average total cost (ATC). Understanding the average cost curve helps a firm determine the cost efficiency of its production process at different levels of output. #Step 2: Identify the profit-maximizing level of output#

To determine whether a firm is making profits or losses, we need to find the profit-maximizing level of output, which is the point at which the firm maximizes the difference between its total revenue (TR) and total cost (TC). The profit is maximized when the marginal cost (MC) equals marginal revenue (MR). Mathematically, this can be represented as MC = MR. #Step 3: Compare the average total cost to the market price#

Once the profit-maximizing level of output is identified, we can use the average cost curve to check whether the firm is making profits or losses. To do this, we need to compare the average total cost (ATC) at the profit-maximizing level of output to the market price (P) that the firm receives for its product. - If ATC < P at the profit-maximizing level of output then the firm is making a profit. - If ATC > P at the profit-maximizing level of output then the firm is making a loss. - If ATC = P at the profit-maximizing level of output, then the firm is breaking even, meaning that it's not making any profit or loss. #Step 4: Interpret the results#

Depending on the comparison of ATC and P from Step 3, we can now determine if the firm is making a profit or a loss at the profit-maximizing level of output using the average cost curve. If the firm is making a profit, the difference between ATC and P indicates the profit per unit sold, while if the firm is making a loss, the difference between ATC and P indicates the loss per unit sold.

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

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