Question

Sonya and Leah operate a small firm in a perfectly competitive market, the diagram illustrates its MC, ATC, AVC and MR curves.

1. What is their current average revenue per unit?

2. What is their profit maximizing level of output and profit?

3. If the market clearing price drops to $10.00 per unit, should they continue to produce in the short run if they wish to maximize their economic profits (or minimize its economic losses)? Explain.

4. What is their shutdown price? Explain.

MC ATC 16.00 MR 12.25 12.00 F= ====== 10.00 ------- AVC Price and Cost ($ per unit) 8.00 6.00- 4.00 6 Output Per hour 10 11 12 13

Answer 1

1. In the perfect competition the demand is perfectly elastic, for this reason the price is equal to the marginal and the average revenue.

Ans: Average revenue : $ .

2. The firm maximizes the profit where the marginal revenue equals the marginal cost of the production.

Ans: Profit maximizing quantity : .

Profit .

= (16-12.25) 13

  .

= 48.75

$48.75.

3). The price is $10 is above the average variable cost and below the average total cost, this means the firm is making the losses but they are covering the variable costs. So it is okay for the firm to continue in the short run but in the long run, in the long run the firm has to make at least zero economic profit to survive in the market. Here the firm should continue in the short run.

4). The shutdown price is where the price equals the average variable costs, if the price is goes below the AVC the firm is even not covering the variable costs so it is not worth to produce so the firm should shutdown. If the price is above the AVC the firm covering the variable costs so they can produce in the short run.

Ans: Shutdown price: $ .