Question

Scenario: The fixed cost of producing 500 units of Good Y is $25,000, while the variable
cost of producing 500 units of Good Y is $60,000.
1. __________ Refer to the scenario above. If the market for Good Y is
monopolistically competitive, a firm producing Good Y will shut down production in
the short run if price falls below ________.
A) $60
B) $200
C) $120
D) $50

2. __________ Refer to the scenario above. Which of the following will happen if the
equilibrium price charged by the firm in the short run is $130?
A) The firm will earn positive economic profits and continue production.
B) The firm will incur a loss but continue production.
C) New firms will enter the industry in the long run.
D) All firms will incur losses in the long run.

3. __________ Refer to the scenario above. If the equilibrium price charged by the
firm in the short run is $170, the firm will earn ________.
A) a profit of $10 per unit
B) a profit of $25 per unit
C) a profit of $0 per unit
D) a profit of $30 per unit

4. __________ Refer to the scenario above. A firm producing Good Y will ________.
A) earn economic profits if it charges a price of 120
B) incur losses if it charges a price of $200
C) earn zero economic profits if it charges a price of $170
D) shut down production if price falls below $200

5. __________ Refer to the scenario above. A firm producing Good Y will continue
production in the short run if total revenue exceeds ________.
A) $25,000
B) $60,000
C) $85,000
D) $35,000

Answer 1

1.Option C ie $120

Average Variable Cost = Total Variable Cost / Output. AVC = 60,000 / 500 = $120. In the short run when Price falls below AVC then firm should shutdown.

2. Option B

Equilibrium Price is $130 and AVC is $120. Since Price is greater than AVC then firm should continue production. However the firm will incur loss. Economic Profit / Loss = Total Revenue - Total Cost. Total Revenue = 500 * 130 = $65000. Total Cost = Fixed Cost+ Variable Cost = 25000 + 65000 = $85000. Economic Loss = 65000 - 85000 = -$25000

3. Option C

When Equilibrium Price charged is $170. Total Revenue = 170 * 500 = $85000. Total Cost = $25000 + $60000 = $85000. Total Profit = Total Revenue - Total Cost = $85000 - $85000 = $0

4. Option C

At price of $170 the firm will earn zero economic profit. Total Profit at price of $170 = $85000 - $85000 = $0. ( This has already been calculated in part 3.) Option A is wrong. At price of $120, Total Revenue = 500 * 120 = $60,000. Total Cost = 85000. Firm will earn Economic Loss = 60000 - 85000 = -$25000. Option B is wrong. At price of $200, Total Revenue = 500 * 200 = $100000. Total Cost = $85000. Firm will earn Economic Profit = 100000 - 85000 = $15000. Option D is wrong. At price of $200, Price will be greater than AVC of $120. So, firm should continue production.

5.Option B

A firm will continue production until Total Revenue exceeds Total Variable Cost ie Total Revenue is greater than $60,000. If the total revenue the firm is making is greater than the variable cost (R>VC) then the firm is covering it’s variable costs and there is additional revenue to partially or entirely cover the fixed costs. But if VC > Revenue then firm should shut down, because in this case firm will be unable to cover its production cost.