This firm’s supply curve is
(a) the average cost curve above the marginal cost.
(b) the marginal cost curve above average variable cost.
(c) the marginal cost curve above the average cost.
(d) indeterminate.
(e) perfectly elastic.
The correct answer and explanation is:
The correct answer is (b) the marginal cost curve above average variable cost.
Explanation:
In economics, a firm’s supply curve represents the relationship between the price of a good or service and the quantity that a firm is willing to produce and offer for sale, holding all other factors constant. For a perfectly competitive firm, the supply curve is determined by its marginal cost (MC) curve above the average variable cost (AVC).
Here’s why:
- Marginal Cost (MC): This curve shows the cost of producing an additional unit of output. It is crucial in determining the firm’s optimal production level since a firm will only produce where its marginal cost equals the market price in a competitive market.
- Average Variable Cost (AVC): The average variable cost is the per-unit cost of variable inputs, such as labor and raw materials, which change with production levels. In the short run, the firm needs to cover its variable costs to continue production.
- Supply Curve and AVC: A firm will only produce in the short run if the market price is above its average variable cost. If the price is below AVC, the firm would not be able to cover its variable costs and would shut down in the short run to minimize losses. Therefore, the firm’s supply curve begins at the point where the MC curve intersects the AVC curve.
- Above AVC: The marginal cost curve above the AVC reflects the range where the firm can cover its variable costs and contribute towards fixed costs. In this region, the firm is incentivized to produce and supply goods to the market.
In summary, the firm’s supply curve in the short run is represented by the portion of the marginal cost curve above the average variable cost. This is because the firm will only produce and supply goods to the market when the price is high enough to cover its variable costs.