Answer the following question based on the chart below: Q Total Cost Fixed Cost Total Variable...

Answer the following question based on the chart below:

Q	Total Cost	Fixed Cost	Total Variable Cost	AVC	Marginal Cost
0	$12		--	--	-
1	$17
2	$23
3	$29
4	$37
5	$47

If the good is selling for $8, the optimal amount for this firm to produce in the short run is? When would the firm shut-down in the short-run (i.e. at what price)? What if the price of the good was $5.50? What would the firm do if the price fell to $2? What about in the long-run?

Expert Solution

Since in the perfectly competitive firm, there are large number of buyers and sellers and they sell identical product and price is determined by industry and not by the firm. So any firm or any buyers can buy or sell any quantity of goods at the market price. It means there is no effect of the individual demand or supply of goods on the market price. It means production decisions cannot affect the market price. There is perfect information about the product to the buyers and sellers.

The profit-maximizing condition of perfectly competitive firm is

P=MC

In perfect competition price, MR and demand curve are same.

Hence corresponding to this condition, quantity is 4 units.

At this quantity loss is minimized and loss is -$5.

Shut-down condition is

MC=minimum of AVC=P

Hence firm should shut-down when price is $5 and quantity is 1 unit.

When price $5.5, then firm should continue to produce because firm is earning more than the total variable cost in the short-run.

When price $2, then firm should shut-down because firm is not able to cover its variable cost. Hence firm should shut-down and minimize its loss equal to fixed cost of $12.

Since at optimal condition firm is earning economic loss of $5, so in the long-run firm should exit the industry.

Rahul Sunny answered 1 year ago

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