Question

Willa is a potato farmer and the world potato market is perfectly competitive.

The market price is $ 23 a basket.

Willa sells 800 baskets a week and her marginal cost is $ 25 a basket.

The market price falls to $ 20 a basket, and Willa cuts her output to 500 baskets a week.

Willa's average variable cost and marginal cost fall to $ 20 a basket. Willa is ______.

A.

maximizing profit and she is incurring an economic loss

B.

maximizing profit and she is making an economic profit

C.

not maximizing profit because she has cut her potato production

D.

not maximizing profit because she is incurring an economic loss

E.

not maximizing profit because marginal revenue does not equal marginal cost

Answer 1

Answer : The answer is option D.

When price is $20 then the marginal cost and average variable cost both are $20. Average variable cost always lie below the average total cost. In perfectly competitive market the firm's equilibrium condition is price = marginal cost. When at a point the price is equal to average variable cost then that point is a shutdown point. Based on given information, when Price = Marginal cost = Average variable cost = $20, then Willa faces a situation of economic loss. As a result, Willa does not maximizing the profit at $20 price level. Therefore, option D is correct.