Question

Consider a perfectly competitive firm that is producing a level of output such that marginal revenue is equal to marginal cost. The firm is selling its output at a price of $10 per unit and is incurring average variable costs of $5 per unit and average total costs of $8 per unit. Given this information, it may be concluded that the firm:

1) is making a profit
2) is incurring a loss
3) is breaking even
4) cannot be determined

Answer 1

The firm is making a profit because it sells its product at a price ($10) that is higher than the average total cost ($8) per unit, yielding a profit of $2 per unit. The correct answer is option 1.

Step-by-step explanation:

Given that a perfectly competitive firm is producing output where marginal revenue equals marginal cost, and the firm is selling its product at $10 per unit while incurring average variable costs of $5 per unit and average total costs of $8 per unit, it can be concluded that this firm is making a profit.

The profit can be determined by the difference between the selling price and the average total cost. In this case, since the price ($10) is higher than the average total cost ($8), the firm makes a profit of $2 per unit ($10 - $8). To calculate total profit, this amount would be multiplied by the total output (number of units sold).

According to the principles of perfect competition, total revenue increases at a constant rate determined by the market price as output increases. Profits are thus maximized when the price, or marginal revenue, equals marginal cost, and if this market price is above the average cost at the profit-maximizing output, the firm sees profits as demonstrated in this scenario.