Question

Fantastic Farm Fixtures (FFF) manufactures irrigation system equipment. The wholesale irrigation equipment market is highly competitive, with systems currently selling for $10,000 each. FFF’s total and marginal cost curves are: T C = 2500000 + 2q 2 MC = 4q where q is the number of systems manufactured each year. (a) Calculate FFF’s profit-maximizing quantity. Is the firm earning a profit? (b) Analyze FFF’s position in terms of the shutdown condition. Should FFF operate or shut down in the short run? Be explicit about what criteria are most important to the decision. (c) In light of your answer to (b), how would you advise FFF to proceed in the long run? Use no less than one and no more than two complete sentences to clearly articulate your main insights.

Answer 1

Brief description:

In short run If firm shut downs then it will still incur fixed cost and is that cost cost which is independent of Quantity and according to given TC = 2500000 + 2q² is FC = 2500000 and Hence If firm shut downs It will incur loss of Fixed Cost(FC). Hence In the short run A firm will shut down If it fails to recover the Variable Cost and is that cost which depends on Output and hence In this case VC = 2q²

Hence firm shut downs If TR(Total Revenue) < VC => PQ < Q*AVC => P < AVC(Average variable Cost)

(a)

In order to maximize profit a perfect competitive firm produces that quantity at which P = MC and here MC = 4Q and p = 10,000 => q = 10,000/4 = 2500

Profit = TR(Total revenue) - TC = 10,000*2500 - (2500000 + 2500²) = 10000000

Hence Profit earned = $10,000,000

(b) Using details given above,  A firm shut down in the short run If TR < VC => P < AVC.

Here P = 10,000 and AVC = VC/q = 2q = 5000. Hence P > AVC => TR > VC. Hence. Firm will not shut down in the short run.

Hence Firm should operate in the short run.

(c)

In the Long run there there is no fixed cost as hence he can sell his fixed asset. hence In the Long run a firm will shutdown If he incur losses. But, here he is earning profit of 10,000,000. Hence he should remain in the market in the long run.