Consider a small enterprise engaged in producing and selling lemonade, operating in a market among numerous other firms with similar ventures. This enterprise, aiming to maximize profits without incurring losses, assesses its production costs to determine the optimal quantity of lemonade to produce.
A crucial principle for this enterprise involves examining two critical cost aspects: the cost of producing an additional unit of lemonade, known as the marginal cost (MC), and the lowest cost at which lemonade can be produced without financial loss in the short run, referred to as the minimum average variable cost (AVC).
The enterprise commences production only when the selling price surpasses the minimum value of AVC. Here lies the pivotal strategy: the decision on the quantity of lemonade to produce is guided by the MC, specifically the segment of the MC exceeding the AVC. This segment above the AVC serves as a directive, indicating the appropriate quantity of lemonade to supply at a given price. This mechanism, known as the supply curve, is crucial for the enterprise in navigating the competitive market landscape.
From Chapter 8:
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