Question

Suppose the spinach industry is perfectly competitive. The price of a bag of spinach is $2.00. A representative firm in this industry, Spinach Is US, Inc. (SIUI), produces 1,000 bags of spinach per day. The average production cost at this output level is $1.50 per bag. (a) In a well-labeled graph show the point where SIUI produces. (b) What is the marginal cost of the 1000th bag? (c) Is SIUI making an economic profit, normal profit, or economic loss, and how much? (d) Is SIUI in the long–run equilibrium? Why or why not?

Answer 1

(a) In following graph, P0 (Demand = MR) intersects MC at point A with output q0 (= 1,000). Since Average cost is less than price when output is 1000, ATC lies below Price line.

(b) When q0 = 1000, Marginal cost (MC) = Price = $2.

(c) Since Price > ATC, the firm is making an economic profit.

Profit = q0 x (P - ATC) = 1,000 x $(2 - 1.5) = 1,000 x $0.5 = $500

(d) SIUI is not in the long-run equilibrium because perfectly competitive firms earn zero profit in long run, while SIUI is making positive economic profit.