Final answer:
The average total cost is calculated by dividing total cost by the output quantity and it usually forms a U-shaped curve on a graph. If a firm's average cost of production is less than the market price, it earns profits; otherwise, it incurs losses.
Step-by-step explanation:
We calculate average total cost by taking total cost and dividing by total output at each different level of output. When plot on a graph, average costs are typically U-shaped. This is because at lower levels of production, the average total cost is higher due to the spreading of fixed costs over a small number of units. As production increases, average total cost decreases due to economies of scale but eventually rises due to diseconomies of scale.
For example, if a firm's average cost of production is lower than the market price, the firm will be earning profits. This is seen in the case of plants producing toaster ovens, where the average cost of production decreases as the output increases from 30 units to 150 units, indicating economies of scale.
However, when the price is less than the average cost of production, the firm will not make a profit and would incur losses. For instance, if the firm's average cost is $26/unit but the market price is $25/unit, the firm will lose $1 for each unit produced.