Question

Suppose, at a given point in time, Sally's Smoothie Shack operates in a perfectly competitive market and is producing its profit-maximizing level of output. Suppose further that at this level of production its average fixed cost of producing a smoothie is $1.30, the average variable cost is $2.50, and the marginal cost is $3.60. At this moment Sally is earning _____ economic profits. Over time, everything else held constant, the quantity of smoothies transacted in the market will _____.

Answer 1

Ans: At this moment Sally is earning negative  economic profits. Over time, everything else held constant, the quantity of smoothies transacted in the market will decrease.

Explanation:

Under perfect competition , the profit maximization condition is where price equals marginal cost ( P = MC) . At the profit maximization level of output , P = AR = MR = MC.

In the above scenario;

Market price = $3.60 ( becuase , P = MC )

Average fixed cost = $1.30

Average variable cost = $2.50

Average total cost = Average fixed cost + Average variable cost = $1.30 + $2.50 = $3.80

At the profit maximization level of output , Average total cost > Market price . So the firm earns negative economic profit or loss .