Costs, revenues and profits: Concept of profit maximisation

Overview

Recall questions on The concept of profit maximisation, The difference between normal and abnormal profits.

What you need to know

Answer each one before you reveal it.

Questions from this subtopic

Each one with the model answer underneath.

1. 1

   What does each short run average cost curve represent when deriving the long run average cost curve?

   Model answer

   Each short run average cost curve represents a different scale of plant or fixed factor combination.

2. 2

   How is the long run average cost curve derived from short run average cost curves?

   Model answer

   The LRAC is an envelope curve drawn tangent to each SRAC curve, touching each at one point.

3. 3

   What does the long run average cost curve show?

   Model answer

   The minimum average cost achievable at each output level when all factors of production are variable.

4. 4

   Why is the long run average cost curve typically U-shaped?

   Model answer

   Due to economies of scale at lower output levels causing average costs to fall, and diseconomies of scale at higher output levels causing average costs to rise.

5. 5

   At what point does profit maximisation occur?

   Model answer

   Where marginal revenue equals marginal cost (MR = MC).

6. 6

   At what output level is profit maximised and why?

   Model answer

   At the output where MR = MC, because at this point neither increasing nor decreasing output would improve profit.

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