Question

2. The gains and loss from selling one more unit 

Alex's Fire Engines is the sole seller of fire engines in the fictional country of Pyrotania. Initially, Alex produced five fire engines, but he has decided to increase production to six fire engines. The following graph shows the demand curve Alex faces. As you can see, to sell the additional engine, Alex must lower his price from $105,000 to $90,000 per fire engine. Note that although Alex gains revenue from the additional engine he sells, he also loses revenue from the initial five engines because he sells them all at the lower price. 

Use the purple rectangle (diamond symbols) to shade the area representing the revenue lost from the initial five engines by selling at $90,000 rather than $105,000. Then use the green rectangle (triangle symbols) to shade the area representing the revenue gained from selling an additional engine at $90,000.

Alex _______ increase production from 5 to 6 fire engines.

True or False: If Alex's Fire Engines were a competitive firm instead and $105,000 were the market price for an engine, decreasing its price from $105,000 to $90,000 would result in the same change in production quantity and, thus, total revenue.

Answer 1

Revenue lost = ($105,000 - $90,000) * 5 engines = $75,000

Revenue gained = $90,000 * 1 engine = $90,000

Since the revenue gained is bigger than the revenue lost, Alex should increase production from 5 to 6 fire engines.

It's false.

The demand curve faced by perfectly competitive firms is horizontal instead of downward sloping because price= marginal revenue = average revenue remains constant. Therefore, the output effect and total revenue would be different.