Question

Suppose a firm is producing a level of output such that marginal revenue is equal to marginal cost. The firm is selling its output at a price of $6 per unit and is incurring average variable costs of $7 per unit and average total costs of $8 per unit. Given this information, it may be concluded that the firm:

Group of answer choices

is operating at maximum total profit

is operating at a loss that could be reduced by shutting down

is operating at a profit that could be increased by producing more output

is operating at a loss that is less than the loss incurred by shutting down

Answer 1

Answer - is operating at a loss that could be reduced by shutting down

As per the information given in the question

a. The firm is producing a level of output where the MR=MC. That implies that the firm is in the profit maximizing output.

b. Price = $6, AVC = $7 and ATC = $8

From the above it can be said that the firm is running under economic loss as it price is less than ATC. It means the firm is under a loss of $2 per unit.

Per unit profit (loss) = Price - ATC

Loss = $6 - $8 = -$2

So there is a loss of $2. Now, question comes whether the firm will continue to operate in the short run or shut down. The shut down point is Price equal to average variable cost. Any price below the average variable cost, the firm will shut down. Here the AVC is $7 which is more than the price. Hence, the firm will shut down. If the firm will shut down, the entire fixed cost will be the loss. In the is case as the quantity is not provided we cannot calculate the total fixed cost. However, the average fixed cost is $1 (ATC - AVC)

If the firm continues, the loss is $2 per unit

If the firm does not continues, the loss is $1 per unit.

Therefore, the firm is is operating at a loss that could be reduced by shutting down.