A firm will earn economic profits whenever:
A. average revenue exceeds average variable costs.
B. marginal revenue exceeds variable costs.
C. average revenue exceeds average total costs.
D. marginal revenue exceeds marginal costs.
The Correct Answer and Explanation is
Correct Answer: C. average revenue exceeds average total costs.
Explanation:
A firm earns economic profit when its total revenue exceeds total costs, including both explicit costs (e.g., wages, rent) and implicit costs (e.g., opportunity costs of using the owner’s time or capital). In microeconomics, this condition can be expressed in terms of average revenue (AR) and average total cost (ATC).
Key Concepts:
Average Revenue (AR): This is the revenue per unit of output sold. In perfectly competitive markets, AR equals the price of the product.
Average Total Cost (ATC): This is the total cost per unit of output, which includes both fixed and variable costs.
Economic Profit: This is different from accounting profit. It takes into account opportunity costs, meaning it shows whether resources could earn more in their next best alternative use.
So, the firm earns economic profit when:
AR > ATC
This means the revenue from selling each unit of the product is greater than the cost of producing that unit, including both explicit and implicit costs.
Why Not the Other Options?
Option A: AR > AVC (Average Variable Cost)
This condition means the firm is covering its variable costs and can continue to operate in the short run, but it doesn’t guarantee a profit. The firm might still be losing money overall if it’s not covering fixed costs.
Option B: MR > Variable Costs
This is not a standard comparison in economics. Marginal revenue (MR) should be compared to marginal cost (MC), not total variable costs.
Option D: MR > MC
This indicates that the firm should increase output to maximize profit, but it doesn’t necessarily mean the firm is earning an economic profit. It’s about efficiency and optimal production, not profitability.
Conclusion:
Only Option C (AR > ATC) correctly identifies the condition for earning an economic profit, because it accounts for all costs, including opportunity costs.