6.4 Output (Production), Profit, Loss and Supply

Question 1

Individual business

Answer 1

• Under perfect competition the demand curve for the individual business is a horizontal line at the market price.
• To obtain maximum profits for the business, only the given market price and its own cost structure are taken into account when determining its production output.

Question 2

Profit for the Business

Normal Profit

Answer 2

• The business makes normal profit which is the minimum earnings required to prevent the entrepreneur from closing the business and using his factors of production elsewhere.
• Equilibrium is at point e1. The business will produce at this point where SMC = MR.
• At point e1, Q1 goods are produced at a price of P1.
• Point e1 is the Profit Maximisation point of the business.

Question 3

Profit for the business

Economic profit

Answer 3

• This is a profit which is made in addition to normal profits.
• This is the difference between Total Revenue and Total Cost.
• Business maximizes profit at point e2.
• Equilibrium is at point e2. At this point SMC = MR.
• The business produces at market price P2 and the quantity produced is Q2.
• The averages cost for Q2 units is point R on the SAC curve.
• Price (or AR) is greater than SAC. (TR > TC)

Question 4

Loss for the business

Answer 4

• The minimum point of the SAC curve is higher than the market price P3.
• The business (firm) is in equilibrium is at point e3. The firm will produce
where SMC = MR.
• At point e3, Q3 goods are produced at a price of P3.
• At equilibrium (point e3) Price/AR is less than Average Cost.
• The AC lies above the demand curve which means that P/AR < AC (TR <
TC)
• The business makes an economic loss.

Question 5

SHUTDOWN POINT

Answer 5

• The rising part of the businesses’ MC curve above the minimum of its average variable cost curve represents the supply curve of the business.
• The supply curve starts at point A (shutdown-point) and slopes upward from there due to the marginal cost that increases as output increases.
• At a market price of P1 the business is only able to pay its variable costs.
• If the market price drops below P1 the business will be forced to close down and
this point (A) is known as shutdown-point.

Question 6

6.4.2 The industry’s long-term equilibrium

Answer 6

• The industry is in equilibrium at the price that clears the market.
• It is the price at which the quantity demanded is exactly equal to the quantity supplied.

Question 7

1. In the long run, two things can change:

Answer 7

(a) New businesses can enter or leave the market.
(b) Businesses can adjust their production capacity.
All factors of production become variable and existing firms earning economic profit in the short run may decide to expand their plant size to realize economies of scale.

Question 8

2. Economic profit

Answer 8

• Suppose the business’s short-term plant is represented by SAC1.
• If the market price is P1 the business is making an economic profit of
P1E1FP2 with the short-term plant-size represented by SAC1.
• At a price of P1 the business will maximise profit in the short-term at point
E1 where the profit maximisation (MR=MC) applies, and the quantity q1 will be produced.

Question 9

3. Bigger plant, lower unit cost

Answer 9

• If the producer does a cost estimate, he/she will realize that he/she will be able to produce at a lower unit cost in the long-run.
• This is illustrated by the downward sloping portion of the LAC curve.
• The prospect of increased profit would therefore encourage the producer
to build a bigger plant.
• The business would however not be interested in producing output levels
greater than those presented by the minimum point E2 of the LAC because such output levels are only possible at higher cost levels – internal scale disadvantages cause the LAC to rise to the right of point E2.