Question

1. A competitive firm sells its output for $20 per unit. When the firm produces 200 units of output, average variable cost is $16, marginal cost is $18, and average total cost is $23. (4 points)
   1. What is the firm’s total revenue, total cost, and profit at the 200units of production?
   2. What is the firm’s fixed cost for 200 units?
   3. Compare the firm’s profit or loss at 200 units of output to if the firm would shut down. Does it make sense for the firm to shut down?

Answer 1

a) Given- output= 200 units, price=$20, average variable cost at 200 units= $16, average total cost at 200 units= $23.

Total revenue= Price x quantity

Total revenue= $20 x 200

Total revenue= $4,000

Total cost= Average total cost x quantity

Total cost= $23 x 200

Total cost of 200 units= $4,600

As at output of 200 units, Total cost>Total revenue, so the firm is incurring losses.

Losses= Total cost - Total revenue

Losses= $4,600 - $4,000

Losses= $600.

Hence, at output of 200 units, firm is incurring losses of $600.

b) Fixed costs are the costs incurred on the use of fixed factors of production. They are independent of output and do not change with a change in the level of output. At every level of output, fixed costs can be calculated as -

Total fixed costs= Total costs - Total variable costs

At output of 200 units, average variable cost= $16 and average total cost= $23.

So, Total variable cost= average variable cost x quantity

Total variable cost= $16 x 200

Total variable cost=$ 3200

Now, Total cost= Average total cost x quantity

Total cost= $23 x 200

Total cost= $4,600

Total fixed costs= Total cost - Total variable cost

Total fixed costs= $4,600 -$3,200

Total fixed costs= $1,400

Hence, total fixed costs are $1,400.

c) The firm is incurring a loss of $600 when 200 units of output are produced. The average variable cost of producing 200 units is $16 whereas the price of each unit is $20.

A firm would shut down if price is less than average variable cost. If the price is equal to or more than average variable cost, then the firm would choose to continue producing. This is because if price is less than average variable cost, then losses in case of producing (fixed cost+ variable cost) are more than losses in case of shut down (losses in case of shut down=fixed costs). Hence, if price is lower than average variable cost, the firm would choose to shut down to minimize losses.

Here, in the question, we can see that at output of 200 units, price is less than average variable cost (P<AVC). Here, price is$20 and average variable cost is $16. As such, the firm would choose to shut down to minimize losses.

Yes, it does make sense to shut down. When price is less than average variable cost, then losses in case of producing are fixed costs plus variable cost . When the firm shut downs, it produces nothing and no variable costs are incurred. Only fixed costs are incurred. As such, losses in case of shut down are equal to fixed costs. So, losses in case of producing output when average variable cost is less than price are more than losses in case of shut down. Hence to minimize losses, the firm would shut down.