Question

Sam runs his business in a perfectly competitive market. At the point where marginal cost equals marginal revenue, ATC=$50, AVC=$25, and the price per unit is $55. In this situation,

Select one:

a. the market price will rise in the short run to increase profits.

b. Sam's business is earning a positive economic profit.

c. Sam's business is losing money in the short run, but should continue to operate.

d. Sam's business should shut down immediately.

Answer 1

In perfectly competitive market, price remain constant and equals to MR and equilibrium arises where Price=MR=MC

In this market, if a firm raises its price, then its economic profit become zero because due to perfect knowledge, consumer will starts to buy from other firms who are selling at lower price. So option a is not correct.

Here, at equilibrium

Price= $55

ATC=$50

AVC= $25

As AVC<Price, it means that Sam's business is able to cover its variable cost so it will not shut down its business. So option d is not correct.

Also at equilibrium, ATC<Price which means that Sam's business is earning a supernormal or positive economic profit.

Option b is the correct answer