Principles of Economics

Running head: PRINCIPLES OF ECONOMICS
Principles of economics
Name of the Student
Name of the University
Author’s Note

1PRINCIPLES OF ECONOMICS
Table of Contents
Answer 1..........................................................................................................................................2
Answer 2..........................................................................................................................................5
Answer 3..........................................................................................................................................6
Answer 4........................................................................................................................................11
References......................................................................................................................................13

2PRINCIPLES OF ECONOMICS
AR=MR
MC
Output
Price
Q
P
Answer 1
a) 1In perfectly competitive market, an entity is a price taker as other entities can easily enter
the market and manufacture the product, which is indistinguishable from other entity’s
commodities. Moreover, all the firms in perfectly competitive market sells homogenous
commodities and makes easy for them to enter the industry. These two conditions makes
it highly impossible for the entity to set the prices above market prices. However, this
makes it incredible for any entity to set its prices and turns them into price- takers. The
diagram below explains the reasons behind perfectly competitive firm as price taker.
Figure 1: Perfectly competitive firm is a price taker
Source: (As created by Author)
As the demand for the entity’s product in perfect competition is perfectly elastic,
the demand curve is drawn as horizontal line. As reflected in the figure above, based on
the firms MC (Marginal Cost), the output will be at Q where MR (Marginal
Revenue)=MC (Marginal Cost). The price takers mainly accept market price and sells
1 in Economicshelp.org, , 2019, <https://www.economicshelp.org/micro-economic-essays/marketfailure/negative-
externality/> [accessed 6 January 2019].

3PRINCIPLES OF ECONOMICS
Output
Price MC
AC
P MR=AR
E
A
B
Loss
Q
every unit at equal price where Average Revenue is equal to Marginal Revenue
(AR=MR).
b) The firm operating in perfectly competitive market makes loss in short run if average cost
(AC) exceeds average revenue (AR).2 This means that the entity is incurring losses as
each unit cost is declining short of price each unit of output. The diagram below shows
that the losses incurred by the firm is represented by the area ABPE. In this condition, the
entity might continue in producing or exit the market depending on the AVC (average
variable cost).
Figure 2: Perfectly competitive firm making short run loss
Source: (As created by Author)
3For maximizing profit in the perfectly competitive market, entities set marginal revenue
(MR) equals to marginal cost (MC). The diagram below reflects that the entity operating in
perfectly competitive market attains equilibrium at the point E because at this point both
2 K Case, R Fair & S Oster, Principles of economics, in .
3 H Daly, "A further critique of growth economics", in Ecological Economics, vol. 88, 2013, 20-24.