The diagram below represents the equilibrium position of a firm in a perfectly competitive industry. Study it and answer the questions that follow. (a) i. A...

Answer Details

Note on the source diagram. The provided image is incomplete (truncated at the lower part), so the quantity axis and the exact equilibrium output cannot be read with certainty. From the visible portion the axis is labelled Cost/Price, the curves shown are a U-shaped MC and a U-shaped ATC (average total cost), and there is a single horizontal line labelled \(AR = MR\) at the price level $20. Further guide values of $12 and $10 are marked lower on the price axis. Because the firm's demand line \(AR = MR\) is horizontal, the diagram is that of a firm in perfect competition (a price taker). The following gives the method a candidate should apply.

Step 1: Establish the equilibrium output. A profit-maximising firm produces where marginal cost equals marginal revenue. Here \(MR = \$20\), so equilibrium is where the rising MC curve cuts the horizontal \(AR = MR\) line at the price of \(\$20\). Call this output \(Q^{*}\) (the point directly below the MC = MR intersection on the quantity axis).

Step 2: Read the price and average cost at \(Q^{*}\). At the equilibrium output:

• Average revenue (price) \(= AR = \$20\).
• Average total cost \(= ATC\), read where the vertical line at \(Q^{*}\) meets the ATC curve. Using the marked guide value, \(ATC \approx \$12\) at that output (with the minimum of ATC near \(\$10\)).

Step 3: Determine the type and size of profit. Compare price with average cost:

\[ \text{Profit per unit} = AR - ATC = \$20 - \$12 = \$8 \]

Since \(AR (\$20) > ATC (\$12)\), the firm earns supernormal (abnormal) profit. The total supernormal profit is the rectangle of height \((AR - ATC)\) and width \(Q^{*}\):

\[ \text{Total profit} = (AR - ATC)\times Q^{*} = \$8 \times Q^{*} \]

where \(Q^{*}\) is the equilibrium quantity. If instead price had equalled minimum ATC the firm would earn only normal profit, and if price were below minimum ATC it would make a loss.

Step 4: Identify the market. Because \(AR = MR\) is a horizontal straight line, the firm faces a perfectly elastic demand and is a price taker, which identifies the market as perfect competition.

Because the source diagram is incomplete, the exact equilibrium quantity and the precise ATC value at that output cannot be confirmed; the method above is correct and the numerical profit follows once \(Q^{*}\) is read from a complete diagram.