Asked Nov 7, 2019
  1. Use a graph to demonstrate the scenario where a competitive firm would be earning positive profit in the short run. Can this scenario be maintained in the long run? Why?

  2. What are the ‘shutdown point’ and ‘break even point’ of a competitive firm . Explain with diagram.

  3. A competitive market starts in a situation of long run equilibrium. Then there is an increase in demand. Explain what happens in the short run and long run, using necessary diagrams.


Expert Answer

Step 1

1) The firm produces at a price where the industry’s supply is equal to its demand at point e and price P. The firm gets price P for the production of the good. Here the firm produces the good at the point e1 where MC = AR (perfectly elastic as the firm operates in competitive market) at price P. The average cost curve lies below the AR or the price line, that means the revenue are greater than cost. Therefore, there is a positive profit in the short run and the total profit of the firm is equal to Pe1P’K (Shaded area)


Image Transcriptionclose

Lost FIRM NAUS TRY MC Aofts AC AR=P ve Q Buaathy Quoakty

Step 2

This situation cannot be maintained in the long run as the market is competitive and there is no restriction to entry of new firms. Therefore, this positive profit will attract more firms into the market and the positive profits will now be normal profits.

Step 3

2) When the price is P’’’ the firm will shut down as it is not being able to cover even its variable cost and thus is at a loss. So, at any price below P’’ the firm will decide to shut down.

When the price is P’’ the firm will run at a break-e...

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