Question

How does the average cost curve help to show whether a firm is making profits or losses?

Short answer

If a company charges a price that is more than its average cost of production for the quantity produced, it will earn profit.

Step-by-step solution

Concept

Average cost refers to the per unit cost of producing a good or service. It is obtained by the ratio of total cost of production and total output produced. The average cost curve is a U-shaped curve.

Explanation

The firm will profit if the average cost curve is lower than the marginal revenue curve, or price, for a given level of output. Only if the company's revenues are insufficient to meet its variable costs should it close.