Question

Suppose that, assuming a firm decides to produce a product, it must build a production facility. The fixed cost of this facility is F = 90. Also, the firm has constant marginal cost, MC = 5. Demand for the product that the firm produces is given by P = 40-5Q.

a) On a single graph, carefully draw the MC curve, the demand curve, and the ATC curve. Your graph should go up to 8 units of output. Please label your graph carefully.

b) How much output will this firm produce if it maximizes its profit?

Suppose the government decides to set the price of the good equal to marginal cost, and subsidize the firm in order to get the firm to produce enough output to satisfy the market at that price.

c) How much should the subsidy be in order to allow the firm to make exactly zero profit.

d) How much consumer surplus will consumers get if P = MC?

Answer 1

a. The table below shows the marginal cost, average total cost and price at various output level ATC MC 40 35 30 25 20 15 10 95 50 35 27.5 23 20 5 17.857145 16.25 4 For the given table, the demand curve, marginal cost curve and average cost curve is as follows PMC/AT 110 100 Demand curve ATC Output b. The firm maximizes profit where marginal cost is equal to marginal revenue Find marginal revenue Marginal revenue- Total revenue) 5(40-500 8(400-50) 40-100 Equate marginal revenue and marginal cost

Marginal revenue Marginal cost 40-1005 35-10Q O- 3.5 The output is 3.5 units C. When P-MC, the output is 7 units. At the output of 7 units, firms make zero profit if its price is equal to ATC. Therefore, firm price should be $15 Subsidy = (S20-$5)-$15 Therefore, govemment should give subsidy of $15. d. Consumer surplus is area above the price line and below demand curve Consumer surplus _-х ($40-$5) x 7 $122.5