Question

Consider a firm facing conventional technology with U-shaped AVC and ATC and MC. The firm wants to maximize profits given an exogenously fixed price of P = $20. Further, suppose the firm correctly determines that its short run profit maximizing output is 1000 given its costs and the exogenously fixed price of $20.

Question 1A Using the axes as constructed below, depict marginal revenue and marginal cost curves that would support the conclusion that the optimal short run output is q = 1000. Be sure to label all important values. Upload graph Question 1B Is this a short run equilibrium? Explain.

Question 2A Reproduce your graph from Question 1, but add an average total cost curve to the picture in such a way that the firm is earning zero profits (π = 0). Upload your graph.

Question 2B Does your graph in Question 2A depict a short run equilibrium? If so, explain why. If not, explain why not. Question 3A Again, reproduce your graph from Question 1. For this question, depict a different ATC curve, one where the firm has negative profits (π < 0) at the profit maximizing output of 1000. Add an additional average cost curve that will allow you to determine whether to shutdown or keep producing at Q = 1000. Question 3B Should the firm produce Q = 1000 in the short run or should it shutdown, producing Q = 0?

Question 3A

Again, reproduce your graph from Question 1. For this question, depict a different ATC curve, one where the firm has negative profits (π < 0) at the profit maximizing output of 1000. Add an additional average cost curve that will allow you to determine whether to shutdown or keep producing at Q = 1000.

Question 3B

Should the firm produce Q = 1000 in the short run or should it shutdown, producing Q = 0?

Answer 1

1A.

1B. Yes, at this point (E^*) MR=MC and company maximizes its profits thus it does not have any incentive from moving up and down from this point, therefore it is short run equilibrium.

2A.

2B. Yes, since company is earning normal profits and MR=MC this implies it is a short run equilibrium and company is maximizing its profits at this point only. Therefore it is an equilibrium.

3A. Figure 1 -

Figure 2 -

3B. As long as company is able to cover it variable cost even though profits are negative it will keep on producing. Therefore, in figures drawn in 3A, in first figure at q=1000 AVC curve is below MC curve that is at this point company is able to cover its variable cost even though ATC curve is above MC that is overall profits are negative therefore company will still keep on producing therefore point A is not a shut down point but in figure 2, at q=1000 AVC curve lies above MC curve that is at this point company is not able to cover even its variable cost, thus company will not operate at this point. Therefore, point C is shut down point of firm.