Th3.4: Profit Maximising Equilibrium

Question 1

Why will the firm produce at MR = MC?

Answer 1

firms are assumed to short run profit maximise

Question 2

In the short run, what different possibilities of profit can be made?

Answer 2

normal profit, supernormal profit or a loss

Question 3

However, firms in perfect competition can only…

Answer 3

make normal profit in the long run - can be seen on Graph 34

Question 4

Refer to PP

Look at Graph 34. What does the shaded area represent for firms in the short run?

Answer 4

the supernormal profit

Question 5

Refer to PP

Look at Graph 34. Prices are set by the market at P1, where S1=D1. As a result…

Answer 5

the firms faces the demand curve of AR1 = MR1 and produce where MC = MR1 at Q1 goods

Question 6

Refer to PP

Look at Graph 34. However, since there is perfect information and ease of entry…

Answer 6

the fact they are making supernormal profits will encourage new entrants to the market, increasing supply from S1 to s2 and lead to a fall in prices from P1 to P2

Question 7

Refer to PP

Look at Graph 34. The firm now has the demand curve AR2 = MR2 and produces…

Answer 7

producers where MC = MR2 at Q2 - this is also where AR2 = AC so they are making normal profits

Question 8

If the firm was making a loss…

Answer 8

firms would leave the industry and this would decrease supply, pushing prices up and reverting to the long run equilbrium