It is usually assumed that a perfectly competitive firm's supply curve is given by its marginal cost curve. In order for this to be true, which of the following additional assumptions are necessary?I.That the firm seek to maximize profits.II.That the marginal cost curve be positively sloped.III.That price exceeds average variable cost.IV.That price exceeds average total cost.
Question
It is usually assumed that a perfectly competitive firm's supply curve is given by its marginal cost curve. In order for this to be true, which of the following additional assumptions are necessary?I.That the firm seek to maximize profits.II.That the marginal cost curve be positively sloped.III.That price exceeds average variable cost.IV.That price exceeds average total cost.
Solution
The assumptions necessary for a perfectly competitive firm's supply curve to be given by its marginal cost curve are:
I. That the firm seeks to maximize profits: This is necessary because firms in perfect competition are price takers. They cannot influence the price of the product or service they are selling. Therefore, they seek to produce at a level where marginal cost equals marginal revenue to maximize profits.
III. That price exceeds average variable cost: This is necessary because if the price does not exceed average variable cost, the firm would be making a loss in the short run and would choose to shut down rather than continue producing.
The other two options are not necessary assumptions:
II. That the marginal cost curve be positively sloped: This is not a necessary assumption. The marginal cost curve can be upward sloping, downward sloping, or even a straight line. What matters is that the firm produces where marginal cost equals marginal revenue.
IV. That price exceeds average total cost: This is not a necessary assumption for the firm's supply curve to be its marginal cost curve. However, if price is less than average total cost, the firm would be making a loss in the long run and would eventually exit the industry.
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