Question

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2. What determines AVC? Explain what AVC depends on.

Why would a firm want to know AVC? Explain how a firm uses AVC.

3. What determines MP? Explain what MP depends on.

Why would a firm want to know MP? Explain how a firm uses MP.

4. What determines ɳ?

Why would a firm want to know ɳ? Explain how a firm uses ɳ.

Answer 1

a1) AVC is the average variable cost , which is calculated as total variable cost per unit of output. AVC = TVC / q

AVC changes with increase or decrease in output. Therefore, AVC depends on total unit of output.

Firm wants to to know AVC because market price of a good produced by the firm needs to be above the AVC to operate in the long run. In a competitive market, price below AVC often leads to a shut down of a business as firm fails to recover its operating costs. Hence, to understand its own cost structure with respect to the firms is required for a firm and thus a firm would want to know about AVC.

In a competitive market, a firm is a price taker and it cannot influence market price. Therefore, if p< AVC of the firm, it should reduce its scale of production , or in other words, production level should be reduced. Ideally, the minimum point of AVC curve is a optimal point for a firm. In below figure, the firm can operate in the competitive market untill P> AVC.