Use Pic 2 for question 8 PriceUnit Costs MC P1 ATC AVC P2 Ps

Use Pic. 2 for question 8. PriceUnit Costs MC P1 ATC AVC P2 Ps Firms output 8. Pic. 2 shows three possible prices for the perfectly competitive firm. The picture also shows its MC, ATC and AVC curves. Which of the following is true? A. at pi, the firm will shut-down. B. at p2, the firm will operate and earn positive profits. C. at p2, the firm will operate and earn negative profits. D. at p, the firm will operate and earn negative profits

Solution

In perfect competition, if P>ATC, firms will operate and earn a positive economic profit. If P<ATC and P>AVC, firms will operate but earn a negative economic profit. If P<AVC, firms will shut down and exit from the market.

Here P1>ATC so firms operate and earn a positive economic profit

P2<ATC but P2>AVC so firms will operate but earn a negative profit

P3<AVC so firms will exit from the market.

Option C is correct.