Sohanlal is a green peas seller in a perfectly competitive industry. He is not as efficient...

Sohanlal is a green peas seller in a perfectly competitive industry. He is not as efficient as other firms. A green peas packet brings an average revenue of Rs. 80, but his average cost is Rs. 100, which includes his average fixed cost of Rs. 50. His profit-maximizing output is 300 pockets.

Q.1 What is his marginal revenue and should he continue in business in the short run?

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Expert Solution

Q1)

His marginal revenue is Rs. 80 and YES, he should continue in business in the short run.

A firm in perfectly competitive market sells all it's units of output at the same market price. It is not required to reduce the price to sell additional units of output. As all the units of output are sold at the same price, the marginal revenue from the sale of an additional unit of output and average revenue earned is same as that of price and is constant. Hence, for a perfectly competitive firm, P=MR=AR. As such, MR of Sohanlal will be same as his Average revenue . Hence , MR= Rs. 80

A firm in the short run has to decide whether it should continue Production or shut down. Even if zero output is produced ( shut down) , fixed costs are to be incurred. Hence, losses in case of shut down is equal to fixed costs. If price is more than or equal to average variable cost, then firm's losses are equal to some fixed costs or fixed costs not covered by price. Hence, when price is more than average variable cost, losses are less than or equal to fixed costs. As such,losses in case of producing when price is more than average variable cost is less than or equal to losses in case of shut down ( zero output). Hence, the firm decides to continue to produce. If price is less than average variable cost, then losses are equal to fixed costs plus variable cost not covered by price. Hence, when price is less than average variable cost, losses incurred are more than losses in case of shut down and hence the firm decides to shut down.

Here , as average total cost is Rs 100 and average fixed cost is Rs 50 ,it means that average variable cost is Rs 50 ( ATC= AFC + AVC). As price ( Rs 80) is more than average variable cost ( Rs 50), the firm should continue to produce in the short run.

Rahul Sunny answered 1 year ago

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