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1. Why would a firm that incurs losses choose to produce rather than shut down?
2. Explain why the industry supply curve is not the long run industry marginal cost curve. 3. In long-run equilibrium, all firms in the industry earn zero economic profit. Why is this true?
4. What is the difference between economic profit and producer surplus?
1. Losses occur when revenues do not cover total
costs. Revenues could be greater than
variable costs, but not total costs, in which case the firm is better off
producing in the short run rather than shutting down, even though they are
incurring a loss. The firm should
compare the level of loss with no production to the level of loss with positive
production, and pick the option that results in the smallest loss. In the short run, losses will be minimized as
long as the firm covers its variable costs. In the long run, all costs are variable, and thus, all costs must be
covered if the firm is to remain in business 2. In the short run, a change in the market price induces
the profit-maximizing firm to change its optimal level of output. This optimal output occurs when price is
equal to marginal cost, as long as marginal cost exceeds average variable
cost. Therefore, the supply curve of the
firm is its marginal cost curve, above average variable cost. (When the price falls below average variable
cost, the firm will shut down.) In the long run, the firm adjusts its inputs so that its
long-run marginal cost is equal to the market price. At this level of output, it is operating on a
short-run marginal cost curve where short-run marginal cost is equal to
price. As the…

g-run price changes,
the firm gradually changes its mix of inputs to minimize cost. Thus, the long-run supply response is this
adjustment from one set of short-run marginal cost curves to another. 3.The theory of perfect competition explicitly assumes
that there are no entry or exit barriers to new participants in an
industry. With free entry, positive
economic profits induce new entrants. As
these firms enter, the supply curve shifts to the right, causing a fall in the
equilibrium price of the product. Entry
will stop, and equilibrium will be achieved, when economic profits have fallen
to zero. 4.While economic profit is the difference between total
revenue and total cost, producer surplus is the difference between total
revenue and total variable cost. The
difference between economic profit and producer surplus is the fixed cost of
production.

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