Question

1.) At current output a profit maximizing competitive firm gets $8 per unit produced and has average total costs of $12. When the market price is $8, the firm's marginal cost curve crosses its marginal revenue curve where Q=120 units.

a. Draw two graphs side-by-side: On the left side, sketch a representation of the market equilibrium (i.e. supply, demand, market equilibrium quantity and market equilibrium price). On the right side, sketch a representation of the individual competitive firm's cost curves (I haven't provided much information about the actual shape, but draw something consistent with the given data). Make sure the market equilibrium price determined in your leftmost graph appears in your rightmost graph: Each individual firm takes the market price as given!

b. What is the firm's current level of profit? Do you anticipate entry or exit into the market? Explain your reasoning.

2.) Suppose a competitive firm previously set its price at $15 per unit to maximize its profit, which had been positive. Then the market price falls to $12 and the firm adjusts in order to maximize its profits at the decreased price. After these adjustments what can we conclude about the firm’s quantity of output, average total cost, and marginal revenue in terms of being higher, lower, or the same as before?

Answer 1

Answer:-

(1). (a) In the left panel of the following graph, D0 & S0 are market demand & supply curves intersecting at point A with market price P0 (= $8) & market quantity Q0. Firms take this price as taken and it is shown in the right panel where firms produce at point B where P0 intersects MC, with firm output q0 (= 120). At this level, ATC being higher than P0, there is a loss equal to area P0BCD.

(b) Since ATC > Price at current output level, there is a loss.

Loss = q0 x (ATC - P0) = 120 x $(12 - 8) = 120 x $4 = $480

Since firms are making a short run economic loss, exit being free, some firms will exit the market and the process will continue until each existing firm earns zero economic loss.

(2). Firm's quantity of output will increase as demand for the product will increase with a decrease in the price of the commodity.

Average total cost is equal to total cost divided by a number of goods sold.

As the price has decreased and quantity has increased, the average total cost will also, decrease.

Change in total revenue divided by change in total output is equal to marginal revenue as both the things will increase, marginal revenue will remain unchanged.