Question

Sophie has a business where she sells DVDs for $15 each. The average variable cost of production is $10 per unit. The average total cost of production is $16. What should she do in the short run?

a. She should continue operating since the business is earning an economic profit.

b. She should shut down because the sales are NOT covering the average total cost of production.

c. She should shut down since the business is earning zero economic profit.

d. She should continue producing even though the sale price is NOT covering the average total cost of production. What can you conclude about a firm in the short run when its price is less than its average total cost? a. The firm should shut down. b. The firm should exit the market. c. The firm is suffering an economic loss. d. The firm is earning an economic profit Assume that a particular perfectly competitive market is a heavy user of inputs whose outputs can be increased only at an increasing cost. Under these conditions, what will be the short-run supply curve for the market? a. downward sloping b. vertical c. upward sloping d. horizontal What part of the marginal cost curve for a firm is the short-run supply curve? a. It is the entire marginal cost curve. b. It is the marginal cost curve below the price. c. It is the marginal cost curve above the average cost. d. It is the marginal cost curve above the average variable cost.

Answer 1

Q1.

Price of DVDs = $15 per unit

Average variable cost, AVC = $10 per unit

Average total cost, ATC = $16 per unit

It can be observed that the Sophie earns a revenue of $15 per DVD, which is less than the ATC of DVDs. Therefore, Sophie is experiencing losses in the DVD business. However, the marginal revenue from each DVD exceeds the average variable cost of DVDs.

Therefore, Sophie should continue to produce in the short run as she is able to recover her variable costs from the revenue generated.

Ans: d. She should continue producing even though the sale price is NOT covering the average total cost of production.

Q2. If the price is less than tha average total cost in the short run, it can be concluded that the firm is experiencing losses. However, the decision of either shut down or continue to operate in the short run can be arrived at, only after comparing the price with the average variable cost.

If Price > AVC, the firm should continue to operate.

If Price < AVC, the firm should shut down.

Ans: c. The firm is suffering an economic loss

Q3. It is given that inputs of a perfectly competitive firm are produced in an increasing cost industry i.e., the cost of inputs increases with the quantity of inputs demanded.

This indicates that the firm can produce a higher output at a higher marginal cost as the cost of inputs are increasing. Therefore, the marginal cost curve is upward-sloping. The short-run supply curve of a firm is that portion of the marginal cost curve that lies above the average cost curve. Therefore, the supply curve of the firm is upward-sloping.

Ans: c. upward sloping

Q4. The short-run supply curve of a firm is that portion of the marginal cost curve that lies above the average cost curve. This is because, the profit-maximizing quantity is the quantity at which the marginal revenue equals the marginal cost. Moreover, a firm operates only if it recovers the variable costs in the short run from the revenue generated. If the price(marginal revenue) falls below the minimum average variable cost, then the firm shuts down.

Ans: d. It is the marginal cost curve above the average variable cost.