1. Suppose your firm has a U-shaped average variable cost curve and operates in

Question

1. Suppose your firm has a U-shaped average variable cost curve and operates in a perfectly competitive market.

If you produce where the product price (marginal revenue) equals average variable cost (on the upward sloping portion of the AVC curve), then your output will:

A) exceed the profit-maximizing level of output.

B) be smaller than the profit-maximizing level of output.

C) equal the profit-maximizing level of output.

D) generate zero economic profits.

Why is D incorrect? I know A is correct because the Q at the profit maximization point is less than the Q at the point in question, but I'm not sure why D is wrong.

Explanation / Answer

Answer.) A.) Exceed the profit-maximizing level of output.

Understand equilibrium conditions

1.) Equilibrium is achieved when MR is equal to MC. Also remember that at equilibrium MC is lowest.

2.) Any output higher than lowest MC output level would generate negative economic profits. It's so because after lowest MC level, MR is starts declining and MC starts rising.

3.) If price is set at the upward sloping portion of AVC then MC will be even higher than ATC . It's so because MC is lower than ATC till it intersects it at its lowest point. Upward sloping AVC portion is associated with even higher level of MC. This is Why D is incorrect.

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