Question

At its present level of output of 100 units, a perfectly competitive firm discovers that (i) its total fixed costs are $200 and (ii) its marginal cost is $7 and equal to average total cost. At an output level of 50 units, marginal cost is $4 and equal to average variable cost. The price of the commodity being produced is $6.

If the firm wishes to maximize total profits, what should the firm do?

A) increase output.

B) decrease output.

C) increase price.

D) continue to produce the current level of output.

Answer 1

The given information is

Q= 100 units,

a perfectly competitive firm discovers that

TFC= $200 and

marginal cost is $7

average total cost=$7

TC=ATC*Q

=7*100

=700

TR=P*Q

=6*100

=600

Economic Profit=TR-TC

=700-600

=$100

At an output level of 50 units,

Marginal cost is =$4

Average variable cost=$4

The price of the commodity being produced is $6.

TFC=200

TVC=AVC*Q

=4*50

=200

TR=6*50

=300

Loss= TC-TR

=200+200-300

=-$100

TFC=$200

Hence it can be said that at present level of output, the firm experiences losses less than its total fixed cost.

If firm shut down, the loss would be $200 but if firm continue to produce then firm can minimise its loss. The firm should shut down firm when MC=P=AVC.

Hence firm should increase the production of output.

Hence option A is the correct answer.