Question 11: Will a profit-maximising firm in a competitive market produce a positive level of output in the long run if the market price is less than the minimum of AC? Give an explanation.
Answer:
It is not possible for a firm to produce positive level of output in the long run if the market price falls short of the minimum of AC. This is because in the long run there is free entry and exit of firms and all firms earn normal profit. Therefore any firm making losses in long run will stop production.
Let us understand this concept through an example:
At oq1 level of output
Price charged by the firm = OP.
Revenue generated by the firm (TR) = P × Q
= OP × Oq1
= area (rectangle Oq1LP)
Cost of producing Oq1 level of output (TC)= LAC × Quantity of output
ON × Oq1
TC = area (rectangle Oq1KN)
Profit earned by the firm = TR-TC
= area (rectangle Oq1Lp)-area (rectangle Oq1KN)
= - area (rectangle NKLP )
Thus the loss incurred by the firm is equal to the area of the rectangle NKLP.
In the long run all firms earn zero economic profit and if any firm earns loss or negative profit then the firm will shut down its production thus if the firm earn loss i.e. if price is lesser than LAC at any level of output it will not be the profit maximising output level of the firm.
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