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IAI Actuarial Core Principles · Business Economics · Profit maximisation under imperfect competition

A monopolistically competitive private tuition-style firm is in long-run equilibrium, producing 400 units at a price of Rs 150 equal to its average total cost. Its marginal cost at that output is Rs 90. At the minimum point of its ATC curve, ATC is Rs 140. Which statement is correct?

The firm earns zero abnormal profit because price equals average total cost at Rs 150. It has excess capacity since this cost is above the minimum of Rs 140, and price exceeds marginal cost by Rs 60, indicating allocative inefficiency. Profit is not (P - MC) times output.

  1. AThe firm earns zero abnormal profit, has excess capacity, and the price-marginal cost gap is Rs 60Correct
  2. BThe firm earns abnormal profit of Rs 4,000
  3. CThe firm earns zero abnormal profit and is productively efficient because P equals ATC
  4. DThe firm earns abnormal profit of Rs 24,000 because P exceeds MC
  5. The firm is allocatively efficient because ATC exceeds minimum ATC

Explanation

P = ATC = 150, so abnormal profit is zero. ATC of 150 exceeds the minimum of 140, so the firm is not at the efficient scale and has excess capacity. P - MC = 150 - 90 = 60, which shows allocative inefficiency. Rs 24,000 is wrongly computed as (P - MC) x Q, which ignores fixed costs.

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