Question

A firm has hired you as a consultant. This firm is not perfectly competitive--it has some control over prices. This firm is currently selling 1000 units, generating $10,000 in revenues and $12000 in total costs. The marginal revenue is about $4, it costs them about $5 to make another unit. Per unit variable costs are about $5 per unit. Based on your analysis, what do you recommend?

shutdown

operate at a loss

change nothing

decrease price, increase quantity

increase price, decrease quantity

Answer 1

The correct answer is (e) increase price, decrease quantity

In order to maximize profit a firm produces that quantity at which MR = MC or If MR is not equal to MC for any quantity then produces that quantity at which MR is just greater than MC

where MR= Marginal Revenue and MC = Marginal cost

Here Firm is producing 1000 units and it is given that when quantity = 1000 units, MR = 4 and MC = 5. Hence MC > MR, Thus Firm is not maximizing profit. According to properties of Non perfect competitive firm, MR is decreasing.

Thus In order to maximize profit a firm we want Marginal revenue to increase and as MR is decreasing Firm should decrease the quantity.

According to law of demand as quantity decreases, price will increase. Hence Market price will increase.

Hence, the correct answer is (e) increase price, decrease quantity

Note :

In short run a firm will shut down if P < Average Variable cost. Here,Price = Revenue/ quantity = 10,000/1000 = 10 which is greater than average variable cost = 5.

Hence Firm will not shut down.