Question

Firms in the market for soccer balls are selling in a purely competitive market. A firm in the soccer ball market has an output of 5,000 balls, which it sells for $10 each. At the output level of 5,000 the average variable cost is $8.50, the average total cost is $11.00, and the marginal cost is $10. What would you expect the firm to do in the short run? in the long run?

Answer 1

Price, P = $10
Output, Q = 5,000
Average Variable Cost, AVC = $8.50
Average Total Cost, ATC = $11
Marginal Cost, MC = $10

A competitive firm produces at the point in the short run where P = MC and only when P > AVC at that level of output. In this case, P > AVC as 10 > 8.50. So, in the short run firm will continue its production but it is earning negative economic profits because P < ATC. So, in the long run, some firms would exit the industry. This would decrease supply and thereby price will rise until it becomes equal to minimum of ATC. So, in the long run, P = minimum of ATC = MC and firm earns zero economic profits.