Mbeya cement company, which has a rising short-run marginal cost curve is currently
operating at a loss. Mbeya cement company'schief economist says that if the price rises a
little, the output should not be increased because, if its marginal cost would rise and the
company would end up with a bigger loss on a higher volume. Should the chief executive
officer of Mbeya cement company listen to the chief economist?Why or why not
NB: Your explanations should be supposed with a graph for more detail. (5marks)
2.Economist claims that the equilibrium position of each firm in a perfectlycompetitive
industry the equilibrium can be atthepoint where D=P=MR=AR. At that point,you can
notice that the equilibrium market price, average revenue per unit is exactly equal to the
average cost per unit.
This means that AR*Q is exactly equal to AC*Q which means that TR is the same as TC.
Since cost and revenue are the same, this means that there isno profit. so why would any
producer stay in business if there isno profit to be gained from doing so?
NB: Your explanations should be supposed with a graph for more details
1. Should the chief executive officer of Mbeya cement company listen to the chief economist?
Well, let's have a look at the situation with a graph. Imagine we have the quantity of cement produced on the x-axis and the price and marginal cost on the y-axis. As the chief economist pointed out, Mbeya cement company's short-run marginal cost curve is rising, meaning that the cost of producing each additional unit of cement is increasing.
Now, if the company is already operating at a loss, increasing output would only exacerbate the loss because the marginal cost curve is rising. This means that for every additional unit produced, the company would have to sell it for a higher price to cover the increased cost. However, if the price increases only slightly, it wouldn't be enough to compensate for the higher marginal cost. Therefore, the company would end up with an even bigger loss on a higher volume.
So, in this case, it would be prudent for the chief executive officer to listen to the chief economist and not increase output. It's better to minimize losses rather than incur more losses by producing more. It would be a clownish move to ignore the advice and worsen the company's financial situation.
2. Why would any producer stay in business if there is no profit to be gained?
Let's take a look at the graph representing a perfectly competitive industry. In a perfectly competitive market, the equilibrium price, average revenue per unit (AR), and marginal revenue (MR) are all equal because firms are price takers. Additionally, at the equilibrium point, average cost per unit (AC) intersects with AR/MR to determine the level of output.
Now, it is true that at this equilibrium point, AR*Q (total revenue) is equal to AC*Q (total cost). This means that total revenue equals total cost, resulting in zero economic profit. In other words, firms are just covering their costs and not making any extra profit.
While it may seem strange that producers would stay in business without making a profit, there are a few reasons for this:
1) Short-run vs. long-run: In the short run, firms might continue operating even if they are not making a profit because they have fixed costs that they cannot immediately recover. However, in the long run, firms will exit the industry if they consistently experience losses.
2) Alternative opportunities: Sometimes, staying in business and breaking even might still be preferable to the alternative opportunities available. Perhaps there are no other viable industries with higher profits, or shutting down the business would result in even greater losses for the owners.
3) Expectations of future profits: Firms may have optimistic expectations about future market conditions and believe that staying in business will eventually lead to profits. They might anticipate changes in demand, technological advancements, or even favorable government policies that could improve their profitability in the future.
So, while it may seem counterintuitive, there can be various reasons why producers continue to operate even if there are no immediate profits to be gained. It's all about weighing the costs, alternative opportunities, and long-term prospects for profitability. And remember, without the clowns, there would be no circus!
1. Should the chief executive officer of Mbeya cement company listen to the chief economist? Why or why not?
In analyzing whether the chief executive officer (CEO) of Mbeya cement company should listen to the chief economist, we need to consider the concept of marginal cost and its impact on profitability.
The chief economist argues that if the company increases output in response to a small price increase, the marginal cost will also rise. This will result in a bigger loss on a higher volume of production. To understand this, we can examine the graph of the short-run marginal cost curve.
The short-run marginal cost curve typically slopes upward, representing the increasing cost of producing additional units. When the price is below the average variable cost, the company incurs a loss. This can be seen as the gap between the average total cost curve and the price level. By increasing output, the company moves along the marginal cost curve, resulting in an even higher loss.
Therefore, the CEO should consider the advice of the chief economist. Increasing production in response to a small price increase could lead to a further loss, and it would not be financially beneficial for the company in the short run. The CEO needs to carefully analyze the cost and revenue dynamics before making any decisions.
2. Why would any producer stay in business if there is no profit to be gained from doing so?
In a perfectly competitive market, where firms are price takers, the equilibrium point occurs where the market demand (D) is equal to the market price (P), which is also equal to the marginal revenue (MR) and the average revenue per unit (AR).
To understand the situation where average revenue (AR) equals average cost (AC), we can examine the graph of the cost and revenue curves. In a perfectly competitive market, the demand curve is horizontal at the market price, and the marginal revenue curve coincides with the demand curve.
Achieving the equilibrium at the point where AR*Q (total revenue) is exactly equal to AC*Q (total cost) means that total revenue equals total cost (TR = TC). This implies that the producer is covering all costs but not earning any profit.
However, it is important to note that while individual firms may not earn profit in the long run due to intense competition, the market itself can still generate economic profit, attracting new firms.
Some reasons why producers stay in business despite the absence of individual profit include:
1. Entrepreneurial optimism: Producers may believe that they can improve their profits in the future through innovations, cost-cutting measures, or strategic decisions.
2. Economies of scale: Large-scale producers may still operate efficiently and produce at a lower average cost compared to smaller firms, allowing them to stay competitive even without earning profit.
3. Non-monetary factors: Producers may have non-financial motivations such as personal satisfaction, market dominance, or long-term strategic positioning.
4. Barriers to exit: Exiting a market can be costly, especially if the producer has invested heavily in fixed assets or has contractual obligations.
Overall, while individual producers may not earn profit in a perfectly competitive market, various factors can still incentivize them to continue operating in the hope of future profitability or for other non-financial reasons.
1. Should the chief executive officer of Mbeya cement company listen to the chief economist?
To determine whether the chief executive officer should listen to the chief economist, we need to understand the concept of short-run marginal cost and its relationship with output and profit.
In the short run, a firm's marginal cost (MC) curve represents the additional cost of producing one more unit of output. If Mbeya cement company has a rising short-run MC curve, it means that the cost of producing additional units of cement is increasing.
If the company is currently operating at a loss, it implies that its total costs are higher than its total revenue. The chief economist argues that if the price rises, the output should not be increased because it would lead to higher marginal costs and a bigger loss on a higher volume.
To understand this concept graphically, we can plot a typical short-run cost curve. On the y-axis, we have cost (C) and on the x-axis, we have the quantity of output (Q). The short-run MC curve typically rises as output increases due to diminishing returns or other factors.
By plotting the short-run MC curve, we can see that initially, as output increases, the cost of producing an additional unit (MC) is relatively low. However, as more units are produced, the cost of producing additional units starts to rise, indicating diminishing returns or other cost factors.
The chief economist's argument is that if the price of cement increases, the company should not increase output because the higher marginal cost will lead to an even bigger loss on a higher volume. This can be shown graphically by extending the MC curve above the price line.
Therefore, it is advisable for the chief executive officer to listen to the chief economist in this case. Increasing output in the short run would lead to higher marginal costs and a bigger loss, which would not be beneficial for the company.
2. Why would any producer stay in business if there is no profit to be gained from doing so?
In a perfectly competitive market, each firm's equilibrium position occurs at the point where demand (D) equals price (P), marginal revenue (MR), and average revenue (AR). At this point, the equilibrium market price is equal to the average revenue per unit (AR*Q), which is exactly equal to the average cost per unit (AC*Q).
By plotting the average cost, average revenue, and marginal revenue curves on a graph, we can confirm that they intersect at the equilibrium output quantity. However, it is important to note that this equilibrium does not necessarily imply zero profit for all producers.
The equilibrium condition in a perfectly competitive market ensures that each firm is producing at the minimum point of its average cost curve, where costs are equal to revenue. In other words, the firm is operating at efficient production levels and maximizing its output given the market conditions.
While it is true that at this equilibrium point, there is no economic profit (where total revenue equals total cost), firms can still earn normal profit. Normal profit refers to the level of profit necessary to keep producers in business in the long run. It is the minimum profit required to cover the opportunity cost of the resources used in production.
Producers stay in business even if there is no economic profit in the short run because they can at least cover their variable costs and earn a return equal to normal profit. In the long run, if firms continue to operate at a loss, some firms may exit the market, reducing the supply and potentially leading to an increase in prices, allowing the remaining firms to earn economic profits again. This process ensures that the market reaches a new long-run equilibrium.
Therefore, while individual firms may not earn economic profit at a specific point in time due to perfect competition, they can still earn normal profit and maintain their operations to stay in business.