Question

A firm has hired you as a consultant. Their only concern is to maximize profits. This firm is not in a perfectly competitive industry--they have some control over price. They give you the following information:

We're selling 80 units at a price of $20 and at the end of the day we're currently earning revenues of $1600. Our costs are $2000. It costs us about $25 to produce another unit.

Based on your analysis, what would you advise them to do?

		Increase Price and Quantity
		Decrease Price and Quantity
		Shutdown
		Increase Price, Decrease Quantity
		Decrease Price, Increase Quantity

Answer 1

In the given case, the firm is earning losses. Here, net loss = revenue - cost = $20*80 - $2000 = $(1600-2000) = - $400.

If the firm is existing in a competitive market, it will charge P=MC=$25 , thereby, earning revenue of $25*80 = $2000. Then, net profit = revenue - cost = $2000 - $2000 = 0. The firm may either shutdown or continue operations at no profit point.

If the firm is operating like a monopoly having some price control, then it can alter its price and quantity combinations in order to earn maximum profits.

To earn profit, monopoly must charge P>MC i.e, P>25. Now, as price increases , quantity falls. This is because, a monopolist faces downward sloping demand curve. Thus, both option a and b do not hold valid as both price and quantity cannot increase or decrease together. From option e, by decreasing price, monopolist will lose revenue. Hence, option e is also invalid.

The monopolist can increase price (where p>25) and decrease quantity upto the extent that revenue generated is greater than the cost incurred. Suppose, if price charged is $30 and quantity produced is 70 then, revenue earned is 70*$30=$2100 which is greater than cost incurred . Here, the monopolist continue to operate. But if the monopolist produces 60 units at the same price, revenue=$30*60 = $1800. Here, the monopolist will incur loss and must opt for a shutdown.