Association of Chartered Certified Accountants (ACCA) Certification Practice Test

Which part of the marginal cost curve represents a firm's supply curve in a competitive market?

1. The part below the average fixed cost curve

2. The part above the average variable cost curve

3. The entire marginal cost curve

4. The part where marginal cost exceeds average cost

The correct answer is: The part above the average variable cost curve

In a competitive market, a firm's supply curve is represented by the portion of the marginal cost curve that lies above the average variable cost curve. This is because, in the short run, a firm will continue to produce as long as the price covers its variable costs, which is the definition of the shutdown point. When the price received for the product is greater than or equal to the average variable cost, the firm can at least cover its variable costs and contribute something towards its fixed costs. If the price falls below the average variable cost, the firm would minimize its losses by shutting down production. Thus, the relevant segment of the marginal cost curve that serves as the supply curve begins at the point where the marginal cost intersects the average variable cost curve and extends upwards. This reflects the idea that as the price in the market increases, the quantity supplied by the firm also increases, which is a fundamental principle of supply in a competitive market. The average fixed cost curve does not influence the supply decision in the short term since fixed costs are incurred regardless of output, and the entire marginal cost curve is not relevant as firms will not supply at prices below their variable costs. The part of the marginal cost where it exceeds average cost is also not the defining