The diagram below represents the cost and revenue situation of a firm. Use the information in the diagram to
answer the questions that follow.
(a) Why would the firm not produce at (i) Q\(\_1\) (ii) Q\(\_3\) ? [6 marks]
(b) How much profit does the firm make at P\(\_1\)? [4 marks]
(c) If price falls to P\(\_1\)
(i) What quantity would the firm produce? [2 marks]
(ii) What type of profit does the firm make? [2 marks]
(iii) Explain your answer in c(ii). [4 marks]
(d) In which type of market s the firm operating?[2 marks]
Explanation
(a)(i) The firm would not produce at Q\(_1/) because at Q\(_1/) the firm makes only normal profit but the aim is to maximize profit.
(ii) The firm would not produce at Q\(_3/) because at Q\(_3/) marginal cost (MC) would be greater than MR\(_12) since P\(_2/) and Q\(_2/) are the equilibrium price and quantity respectively.
(b) At P\(_2/) , the total profit is the profit per unit, EB, multiplied by the quantity 0Q\(_2/) or P\(_2/) E. Total profit therefore is EB x 0Q\(_2/) or EB x P\(_2/) E.
(c) (i) If price falls to P\(_1/) , the firm would produce Q\(_1/)
(ii) The firm would make just normal profit. (iii) Normal profit is included in the average cost of the firm. When price or average revenue is equal to average cost, then it is only normal profit that is earned.
(d)A perfectly competitive market.