Question

a. If the marginal revenue is less than the marginal cost, what should a profit-maximizing company do?

b. In a perfectly competitive graph, how does one calculate the economic profit?

c. What is the shutdown point in a perfectly competitive firm? '

d. Briefly, what is the difference between economies of scale and diseconomies of scale? Why is it important to the firm?

e. Given the following total cost function TC(q) = 1000 + 13q. Find the fixed cost, variable cost, average total cost, and the marginal cost. How do you know that these costs are in the short-run? Explain.

Answer 1

a) Ans: If the marginal revenue is less than the marginal cost, a profit-maximizing company should decrease production.

Explanation:

The profit maximization condition is where MR = MC

So , if the marginal revenue is less than the marginal cost, a profit-maximizing company should decrease production and vice versa

b) Ans: In a perfectly competitive graph, one calculate the economic profit by the following way;

First identify the profit maximization level of output where P = MC.

Profit = Total Revenue - Total Cost

Total Revenue = Market price (P) * Profit maximization level of output ( Q)

Total Cost = Average total cost ( ATC ) * Profit maximization level of output ( Q)

c) Ans: shutdown point in a perfectly competitive firm occurs where price equals average variable cost (P =AVC ) or ( P < AVC ) at each level of production.

d) Ans: Economies of scale occurs when the cost of production decreases whereas diseconomies of scale occurs where the cost of production increases in the subsequent level of production. These two concept are important from any business or production point of view because profits depend upon this stage.

e) Ans:

Find the fixed cost = 1000

Variable cost = 13q

Average total cost = 1000 / q + 13

Marginal cost = 13

We know that these costs are in the short-run because there are no fixed costs in the long-run.

Explanation:

TC(q) = 1000 + 13q

Fixed costs are available even at zero level of output and remain constant in the subsequent level of production.

Average total cost = (1000/q) + (13q /q ) = 1000 / q + 13

Variable cost = Total cost - Total fixed cost = ( 1000 + 13q ) - 1000 = 13q