Question

The widget industry is perfectly competitive, and the current market price of a widget is $60. A typical firm in this industry chooses to produce 200 widgets. The total fixed cost paid by each firm is $2000.
(a) To produce a quantity of 200 widgets, the firm employs 300 workers, at a wage of $20. What is the firms average variable cost (AVC) at a quantity of 200 widgets?
(b) Sketch a diagram showing the optimal decision of the firm. Your diagram should include the following curves: MC, MR, ATC, AVC.
(c) Label on your diagram the price of $60, the quantity of 200, as well as the values of ATC and AVC at a quantity of 200 units.
(d) What profit/loss is the firm currently making?
(e) In the long run, will the price of widgets be above or below $60? Explain your answer.

Answer 1

The widget industry is perfectly competitive, and the current market price of a widget is $60. A typical firm in this industry chooses to produce 200 widgets. The total fixed cost paid by each firm is $2000.
(a) To produce a quantity of 200 widgets, the firm employs 300 workers, at a wage of $20. AVC is the per unit varianle cost. Since fixed cost is 2000 and variable cost is 20*300 = 6000, the average variable cost is 6000/200 = $30 per unit
(b) Graph is shown below
(c) Graph is labled. ATC is per unit total cost. Total cost is TC = FC + VC = 2000 + 6000 = 8000. ATC = 8000/200 = $40.

(d) Profit or loss = (P - ATC)*Q = (60 - 40)*200 = $4000.
(e) Long run price will fall below this value because at a price of 60 there are economic profits in the short run so this will attract firms in the long run which will reduce the price and increase the quantity.