Economics Short Run Vs Long Run Costs Questions Long
Average profit is a measure of the profitability of a firm and is calculated by dividing total profit by the quantity of output produced. It represents the profit earned per unit of output.
The relationship between average profit and marginal cost is crucial in understanding the behavior of firms in the short run. Marginal cost refers to the additional cost incurred by producing one more unit of output. It is calculated by dividing the change in total cost by the change in quantity.
In the short run, a firm aims to maximize its profit. To determine the optimal level of output, the firm compares the marginal cost with the average profit. If the marginal cost is lower than the average profit, it implies that producing an additional unit of output will increase the firm's profit. In this case, the firm should increase its production. On the other hand, if the marginal cost exceeds the average profit, producing an additional unit of output will decrease the firm's profit. Therefore, the firm should reduce its production.
The relationship between average profit and marginal cost can be further understood through the concept of diminishing marginal returns. In the short run, firms often experience diminishing marginal returns, which means that as more units of a variable input (such as labor) are added to a fixed input (such as capital), the marginal product of the variable input decreases. This leads to an increase in marginal cost.
As the marginal cost increases, it eventually intersects with the average profit curve. At this point, the firm is producing the optimal level of output where the marginal cost equals the average profit. This is because producing more units would result in a decrease in average profit, as the marginal cost exceeds the average profit. Conversely, producing fewer units would also decrease average profit, as the marginal cost is lower than the average profit.
In summary, the concept of average profit represents the profit earned per unit of output, while marginal cost refers to the additional cost incurred by producing one more unit of output. The relationship between average profit and marginal cost is crucial in determining the optimal level of output for a firm in the short run. The firm should increase production if the marginal cost is lower than the average profit and decrease production if the marginal cost exceeds the average profit. This relationship is influenced by the concept of diminishing marginal returns, where the marginal cost increases as more units of a variable input are added to a fixed input.