Question

The following table represents short run cost-revenue information (in dollars) for a firm in a competitive market.

Q	P	TR	MR	MC	TC	Total Profit
0			N/A	N/A	$1,000
1					1,100
2					1,180
3					1,220
4				$20
5					1,270
6					1,320
7				$80
8				$100
9
10

(a) Fill in all the blanks above using the following information: The Market Price is $50 per unit of output, the TVC of producing 9 units of output is $700, and the ATC of producing 10 units of output is $200

(b) Where does diminishing returns start? Explain your answer.

(c) What is the Fixed Costs for this firm? Explain your answer.

(d) In the Short Run, if this firm would go into production, determine the profit maximizing (or loss minimizing) level of output and profit amount.

(e) In the Short Run, if this firm would instead shutdown without going into production, determine its production amount and profit amount.

(f) Please determine the best course of action for this firm in the Short Run.

(g) Based on the data above, in the Long Run, explain what this firm should do.

Answer 1

a)

To calculate the table:

• TR=P*Q=50Q
• TC_t=TC_t-1+MC_t
• MC_t=TC_t-TC_t-1
• TC=FC+VC
• FC=TC₀
• TC=FC+Q*AVC
• AVC=VC/Q
• ATC=TC/Q

Using the formula avobe the table is calculated below

Q	P	TR	MR	MC	TC	Total Profit	AC	VC	AVC
0	50	0	N/A	N/A	1000	-1000
1	50	50	50	100	1100	-1050	1100	100	100
2	50	100	50	80	1180	-1080	590	180	90
3	50	150	50	40	1220	-1070	406.6667	220	73.33333
4	50	200	50	20	1240	-1040	310	240	60
5	50	250	50	30	1270	-1020	254	270	54
6	50	300	50	50	1,320	-1020	220	320	53.33333
7	50	350	50	80	1400	-1050	200	400	57.14286
8	50	400	50	100	1500	-1100	187.5	500	62.5
9	50	450	50	200	1700	-1250	188.8889	700	77.77778
10	50	500	50	300	2000	-1500	200	1000	100

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b)

The diminishing marginal return refers to the fact that as the firm increases labor employmnet, the addition to the total product for each incremental labor employed decreases. Thus, the cost of employing labor inceases and total output increases at a decreasing rate. This increases the avarage cost of production. Then the as output rises, as diminishing marginal return sets in, the avarage cost rises.

From the table avobe table the avarage cost starts rising after Q=9. Then diminishing return starts in after Q=9.

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c)

Fixed cost is the cost of fixed input of production. The fixed inputs are dose that does not changes in the short run, such as land, capital etc. The fixed cost also does not depend on the level of input. The producers have to incur these costs even if the total production and sales is zero. Thus the fixed cost is total cost at Q=0.

In this case, the fixed cost or the cost at Q=0 is $1000.

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d)

A perfectly competitive firm acts as a price taker. That is it takes price as given by the market forces. Each firm maximizes its profit by equating marginal revenue to its marginal cost. In perfect competition the marginal revenue equals to the price. Therefore, each competitive firm maximizes its profit by producing the level of output for which its marginal cost equals to the market price. Each firm faces the horizontal demand curve given the fact that the firm can sell any amount at a given price.

Therefore, at equilibrium the firm produces at the output level for which P=MC=50. That is at equilibrium from the table Q=6.

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e)

If the firm shuts down it would produce zero output and incurs $1000 cost. Then the profit of the firm would be -$1000

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f)

The profit of a firm is given as

Here AC is average cost, P is the price and Q is the output produced. Thus, the firm will earn above normal profit if price in greater than AC. The supernormal profit encourages entry into any industry. The firm break even at the point where P=MC=AC. This occurs where the MC cuts the AC curve.

The firm operates into an industry as long as it can cover its variable cost. This is because, when the firm is losing money in every unit it produces, this means that every additional unit the firm produces is incurring loss. Therefore, the cost of additional unit of production is greater than the revenue from additional unit. Hence, marginal revenue is less than the marginal cost. On the other hand, if firm sells additional unit then its total revenue will be just enough to cover its variable cost the cost which is increasing and varies with output. If in this stage the firm quit production it will still have to pay the fixed costs. With no revenue, this will prove unprofitable for the firm. On the other hand, if it continues its production it will be able to cover its variable costs, so can incur smaller losses than to close down. If the price falls below average variable cost, it will not be able to cover its variable cost by additional revenue. Then it will be force to close down. Then the shutdown point is P=AVC.

In this case the minimum AVC is $53 fromthe table associated with Q=6. The market price is below this minimum AVC. By shutiing down it would incur loss of $1000 which is less than current loss of $1020. Thus the firm must shut down in the short run.

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g)

In the long run if the market condition improves and prices increases to at least $187.5, the firm may consider reentering the market. Otherwise it shut exit the market in the long run.