WAEC Economics 2012 Theory — Question 1

Model answer

(a)(i) At Q1, price P3 is above the point where MC=MR at the profit maximizing output, and the firm has not reached the output level that minimizes average cost/maximizes profit — producing at Q1 would not maximize profit since it is not where MC intersects MR at the correct level. (ii) At Q3 (beyond the profit-maximizing point where MC=MR), marginal cost exceeds marginal revenue, so producing further reduces profit rather than increasing it. (b) At price P2, the firm produces at output Q2 where MC=MR (point E/D). Profit = (P2 − Average Cost at Q2) × Q2, represented by the rectangle/area bounded by points G, F, E, D on the diagram — this is the abnormal/supernormal profit made at P2. (c)(i) If price falls to P1, the firm would produce at the output level where P1=MC=AR1=MR1 (the point where the AC curve is tangent to the price line). (ii) At P1, the firm makes normal profit only. (iii) This is because at P1, price equals average cost exactly (AR=AC), so total revenue just covers total cost, leaving no abnormal/supernormal profit — only normal profit (which is already included within the cost curve). (d) The firm is operating in a monopolistically competitive or perfectly competitive market structure, given the presence of a U-shaped average cost curve and price-taking behaviour typical of firms operating under such market structures in the short and long run.