Question

Total Product	Average Fixed Cost	Average Variable Cost	Average Total Cost	Marginal Cost
1	$100.00	$17.00	$117.00	$17
2	50.00	16.00	66.00	15
3	33.33	15.00	48.33	13
4	25.00	14.25	39.25	12
5	20.00	14.00	34.00	13
6	16.67	14.00	30.67	14
7	14.29	15.71	30.00	26
8	12.50	17.50	30.00	30
9	11.11	19.44	30.55	35
10	10.00	21.60	31.60	41
11	9.09	24.00	33.09	48
12	8.33	26.67	35.00	56

The accompanying table gives cost data for a firm that is selling in a purely competitive market. If the market price for the firm's product is $12, the competitive firm should produce

Multiple Choice

• 4 units at an economic profit of $31.75.

• 4 units at a loss of $109.

• zero units at a loss of $100.

• 8 units at a loss of $48.80.

Answer 1

The correct answer is (c) zero units at a loss of $100.

In order to maximize profit a firm produces that quantity at which P = MC where P = Market price and MC = Marginal cost. If at this quantity he failed to recover his variable cost then he will shut down because if he produces when he failed to recover his variable cost then he should shut down. He failed to recover his variable cost means that Total Revenue(TR) < Total Variable cost(TVC) => P*Q < AVC*Q => P < AVC where P = Price , AVC = Average variable cost and Variable cost = Average Variable Cost*Quantity.  Thus he should shut down if P < AVC at profit maximizing quantity

Here P = Market price = 12.

We can see from above that MC = P = 12 when quantity(Q) = 4.

We can see from above that when Q = 4, Average variable cost(AVC) = 14.25. Thus at Q = 4 AVC > P. Hence as discussed above this firm should shut down i.e. produce 0 quantity.

When no quantity is produced i.e. Q = 0, then firm will only incur Fixed cost and fixed cost is constant whatever be the quantity.

Fixed cost = Average Fixed cost when Q = 1, Average fixed cost = 100 => Fixed cost = Average fixed cost*Q = 100*1 = 100.

Hence Fixed cost = 100.

Profit = Total revenue - Total cost.

As Quantity = 0, Total Revenue = 0 and Variable cost = 0 as variable cost = 0 when a firm shut downs.Also Fixed cost = 100 when Quantity= 0. because fixed cost is independent of output. Thus, Total Cost = Variable cost + Fixed cost = 0 + 100 = 100.

Hence Profit = Total revenue - Total cost = 0 - 100 = -100(negative sign implies loss).

Thus, the competitive firm should produce zero units at a loss of $100.

Hence, the correct answer is (c) zero units at a loss of $100.