Question

A firm operates in a perfectively competitive industry. Given the market price of 20 and the firm’s marginal cost function MC=-8+2Q. In addition, the average variable cost is equal to the marginal cost at 15 units of output. Use the information to answer questions 14 and 15.

1. Which of the following units of output would be chosen by the firm?

1. 10 units
2. 14 units
3. 22 units
4. 32 units

2. Should the firm continue its business and why?

1. Yes, because the market price is higher than the average variable cost at 15 units of output.
2. Yes, because the market price is lower than the average total cost at 15 units of output.
3. No, because the market price is lower than the average variable cost at 15 units of output.
4. No, because the market price is lower than the average total cost at 15 units of output.

Answer 1

Answer 1: Option b. 14 units.

For a perfectly competitive firm, Price is equal to marginal cost of the firm is the optimum condition. In the above case, equilibrium outout produced by the firm is given by:

20 = -8+2Q

28 = 2Q

Thus, Q = 14 units.

Answer 2: Option a.

The minimum AVC of the firm occurs at the point where AVC = MC, Thus, AVC at 5 units of output = -8 + 2 * 5 = 2.

Since price is higher than minimum AVC of the firm, thus firm should continue its business in the above case.