Question

In the short-run, if there is a positive level of output at which a firm's profit is maximised. Which of the following conditions must hold at that output level?
(A) The price must be less than the short-run avegare cost.
(B) The price must be equal to the short-run marginal cost.
(C) Price must be greater than equal to the short-run average variable cost.
(D) Short-run marginal costs must be non-decreasing.
Choose the correct answer from the options given below:

• A. (A), (B) and (D) only
• B. (A), (C) and (D) only
• C. (A), (B), (C) and (D)
• D. (B), (C) and (D) only

Hint:

Short-run profit maximization conditions:
1. \(P = SMC\)
2. \(SMC\) is non-decreasing
3. \(P \ge AVC\) (Shutdown rule)

Answer 1

The Correct Option is D

Concept:
Under perfect competition, a profit-maximizing competitive firm determines its short-run equilibrium output based on three essential economic criteria.

Step 1: Identifying the Three Profit Maximization Conditions:
1. First-order condition: Price must equal Short-run Marginal Cost: \[ P = SMC \] This matches statement (B).
2. Second-order condition: The marginal cost curve must cut the price line from below, meaning that Short-run Marginal Cost must be non-decreasing at the chosen output level. This matches statement (D).
3. Short-run shutdown condition: To prevent losses exceeding fixed costs, the market price must cover at least the variable costs: \[ P \ge SAVC \] This matches statement (C).

Step 2: Evaluating Statement (A):
Price does not have to be less than Short-run Average Cost (\(SAC\)). If \(P < SAC\), the firm incurs an economic loss. While a firm may operate with losses in the short run if \(P \ge SAVC\), \(P < SAC\) is certainly not a requirement for profit maximization.
Final Answer:
Only conditions (B), (C), and (D) must hold. Thus, option (D) is correct.