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With the aid of three separate graphs, discuss the short-run equilibrium positions (economic profit, economic loss and normal profit) in a perfect market - English General - NSC Economics - Question 5 - 2022 - Paper 2
Question 5
With the aid of three separate graphs, discuss the short-run equilibrium positions (economic profit, economic loss and normal profit) in a perfect market. Analyse t... show full transcript
Worked Solution & Example Answer:With the aid of three separate graphs, discuss the short-run equilibrium positions (economic profit, economic loss and normal profit) in a perfect market - English General - NSC Economics - Question 5 - 2022 - Paper 2
Step 1
Discuss the short-run equilibrium positions (economic profit)
Answer
In a perfectly competitive market, economic profit occurs when a firm’s total revenue exceeds its total costs. This situation happens when the price (P) is higher than the average cost (AC) at the output level where marginal cost (MC) equals marginal revenue (MR).
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Graphical Representation:
Draw a graph with price/cost and quantity on the axes. Label the demand curve (D), MR, MC, and AC accurately.- At price P1, the firm produces Q1 units, where MC = MR.
- The area between the price line and the AC curve is the economic profit area.
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Calculation of Economic Profit:
The economic profit (Pea) can be calculated as:
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Conclusion:
The firm continues to produce as long as it can cover its variable costs and earn positive economic profit.
Step 2
Discuss the short-run equilibrium positions (economic loss)
Answer
Economic loss arises when a firm’s total costs exceed its total revenue. This occurs when the price is less than the average cost.
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Graphical Representation:
Draw another graph with the same axes and indicate a price level (P2) resulting in economic loss.- At a lower price (P2), the firm produces Q2 units where MC = MR.
- The area between the price line and the AC curve indicates the loss.
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Calculation of Economic Loss:
The economic loss can be expressed as:
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Conclusion:
A firm experiencing losses may decide to exit the market in the long run.
Step 3
Discuss the short-run equilibrium positions (normal profit)
Answer
Normal profit occurs when total revenue equals total cost, indicating no incentive for firms to enter or exit the market.
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Graphical Representation:
For the final graph, illustrate the case where AC equals the price (P3) at the profit-maximizing quantity (Q3).- Here, the curve reflects a break-even position.
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Explanation:
This signifies that firms cover all costs, including opportunity costs, just enough to stay in the industry. -
Conclusion:
Long-term survival of firms in the market depends on reaching this normal profit point.
Step 4
Analyse the advantages of perfect competition as a market structure.
Answer
Perfect competition has several advantages:
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Efficient Resource Allocation:
Firms produce at the lowest point on their cost curves, leading to productive efficiency and allowing resources to be allocated efficiently in the economy. -
Consumer Benefits:
Competition drives prices down, benefiting consumers through lower prices and more choices. -
No Entry Barriers:
New firms can enter the market easily, fostering innovation and responsiveness to consumer needs. -
Equitable Distribution:
Firms earn normal profits in the long run, ensuring no monopolistic exploitation occurs.
In summary, perfect competition promotes efficiency and consumer welfare.