Suppose you are a consultant for a firm that is perfectly competitive. The firm is worried only about its policies in the short run.

Suppose you are a consultant for a firm that is perfectly competitive. The firm is worried only about its policies in the short run. What would you recommend in terms of quantity changes (raise, cut, shut down or stay put) and price changes (raise, cut, stay put) in each of the following situations:

a. P = $19 MC = $14 AVC = $20

b. P = $111 MC = $106 AVC = $107

[Notations/Abbreviations: P = price; MC = marginal cost; AVC = average variable cost; ATC = average total cost]

Solutions

Expert Solution

(a) P = $19 MC = $14 AVC = $20

Price - stay and Quantity - stay

Under perfect competition, firms are price takers and they do not have any control over the price of commodity. So, price of commodity will remains the same. Since, firm is not able to average variable cost so firm suffers loss of $ 1 but in short run firm will stay in hope that earning in future will increase. Since, P > MC which means that cost of additional output is less than the price which firms get on the sale of it.

(b) P = $111 MC = $106 AVC = $107

Price - stay and Quantity - raise

Under this situation, firm is able to cover its variable cost which means firm is earning profit. But since, firms are price takers so price will stay at the same rate while quantity will increase.

Rahul Sunny answered 2 years ago

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