Question

Using an illustration explain how a perfectly competitive firm might be:

Earning an accounting profit and zero economic profit

Earning an accounting profit and an economic profit

Earning an accounting profit and an economic loss.

Be sure to explain in each case what will happen to the number of firms in the market place and why it will happen.

Answer 1

A perfectly competitive firm maximizes profit at the point where marginal cost equals marginal revenue. The equilibrium point is shown by E and equilibrium output by Q in graphs. Economic profit = Total revenue - Total implicit (like opportunity cost) and explicit cost.

Accounting profit = total revenue - explicit cost (paid out cost).