In the short run, a perfectly competitive firm produces output using capital services (a fixed input) and labour services (a variable input).

In the short run, a perfectly competitive firm produces output using capital services (a fixed input) and labour services (a variable input). At its profit-maximizing level of output, the marginal product of labour is equal to the average product of labour.

a. What is the relationship between this firm’s average variable cost and its marginal cost?

b. If the firm has 5 units of capital and the rental price of each unit is €9/day, what will be the firm’s profit? Should it remain open in the short run?

Solutions

Expert Solution

When marginal cost (MC) is less than average variable cost (AVC), average variable cost is decreasing. When marginal cost is greater than average variable cost, average variable cost is increasing.

In this case the profit of the firm will decrease because the cost of capital should be included in total cost. Here, cost of capital is fixed cost so in the short run only a firm has to take into consideration only variable cost. If average variable cost is less than price the firm should remain open.

Rahul Sunny answered 1 year ago

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