Question

3. Consider a firm in a perfectly competitive industry with a cost structure as shown in the table below. (a) If the market price is $360, will the firm produce at all? (b) If so, how much and why that particular quantity? (c) Calculate the economic profit or loss at the optimal level of output. Clearly show any calculations performed and explain reasoning used to arrive at your answers. AFC Output 0 AVC ATC MC Your answers 1 (a) 2 3 4 5 6 7 8 9 $600 300 200 150 120 100 86 76 66 60 $200 150 140 145 160 180 205 232 276 320 $800 450 340 295 280 280 291 314 342 380 $200 100 120 160 220 280 360 460 580 720 (b) 10 (c)

Answer 1

3. a) A perfectly competitive firm decides wheather to produce or shut down in the short run based on the relationship between price and AVC. If the price < AVC, which means Total revenue < TVC, then the firm will shut down in the short run because it won't be able to cover even it's variable cost. If price > AVC, then the firm will continue to operate in the short run.

When price = $360, the profit maximizing output (profit is maximized by producing at the point where price = MC) is 7 units. At this Quantity, AVC = $205, which is less than price. It means, the firm will continue to operate in the short run.

b) A perfectly competitive profit maximizing firm produces optimal output at the point where market price = MC. When price = $360, the firm will produce 7 units.

c) At Q = 7, Total revenue = price * quantity = $(360 * 7) = $2520

Total cost = ATC * quantity = $(291*7) = $2037

Economic profit = TR - TC = $(2520 - 2037) = $483