Question

Initially, the market price is p=20, and the competitive firm's average variable cost is 18, while its average cost is 21. Should it shut down? Why? This firm should O A. not shut down because average cost is greater than average variable cost. OB. shut down because average fixed cost is less than the market price. O C. not shut down because average variable cost is less than the market price. OD. not shut down because average fixed cost is less than the market price. O E. shut down because average cost is greater than the market price. Now this firm's average variable cost increases by 5 at every quantity, while other firms in the market are unaffected. What happens to its average cost? and its average total cost is . (Enter your responses rounded to the The firm's average variable cost is now nearest whole number.) Should this firm shut down? Why? This firm should O A. shut down because average cost is greater than the market price. OB. shut down because average variable cost is greater than the market price. O c. not shut down because average cost is greater than average variable cost. OD. shut down because average fixed cost is less than the market price. O E. not shut down because average fixed cost is less than the market price.

Answer 1

1.

The shut-down of the perfectly competitive firm is

P=MC=Minimum of AVC

Hence firm makes shut down decision when the price falls below minimum average variable cost.

Given

P=20

AVC=18

ATC=21

Since price is greater than the AVC, it means firm is covering some part of fixed cost, therefore firm is minimizing its loss by operating at the current level of output.

Hence this firm should not shut-down because average variable cost is less than the market price.

Hence option C is the correct answer.

2.

Now if AVC increases by $5 at each quantity and other firms in the market are unaffected.

Since ATC=AFC+AVC

Since AFC is unaffected while AVC increase by $5, So ATC will also increase by $5 at each quantity.

Now AVC=$23

ATC=$26

As it can be seen in the data that now AVC is $23 while price is $20, therefore firm should shut-down.

Hence option B is the correct answer.