Question

Graph a perfectly competitive firm earning negative economic profits. Label price, quantity

and ATC. Label and note the four corners of the areas of total revenue, total cost and

profits. Explain the long run adjustment process for firms in this market

Answer 1

Ans) In Perfectly competitive market, price is decided by forces of demand and supply. If price is above ATC, firms earn positive economic profit. Seeing these profits, more firms will enter the market, which will increase the supply and price will go down till it reaches minimum of ATC and firms in long run will earn zero economic profit.

If price is below ATC, some firms will exit the market. Which will lead to decrease in supply and price will increase till it reaches minimum of ATC and firms will again earn zero economic profit in long run.

The graph above shows that the price is below ATC and firms are earning negative economic profit.

Rectangle OQAP represents total revenue.

Rectangle OQB(ATC) represents total cost.

Rectangle (ATC)BAP represents loss.