Suppose you are providing your consulting services to a firm that supplies hubca

Question

Suppose you are providing your consulting services to a firm that supplies hubcaps to the auto industry. The firm aims at maximizing profit, and it competes with many other firms. You estimate the firm’s total and marginal costs to be:

TC = 625 + q2 - 5q MC = 2q - 5

and you believe all other firms in the industry have identical costs. The current price is $40 per unit.

1. Given this information, would you recommend this firm to produce or shut down in the short run? Please make sure to explain you answer and show your calculations.

2. Assume that the hubcap industry is a “constant-cost industry”. What do you predict will happen in the long-run? Specifically, what will be the long-run price, and the quantity produced by the firm? Please show any calculations and also explain in words the economic logic behind your answer.

Explanation / Answer

1) in short run profir is maxmised where MR=MC

2q-5=40 thus Q=22.5 and P=40

Profit=TR-TC=40(22.5)-22.52+5(22.5)-625=-118.75

Thus firm should still produce in short run in order to minimise loss

2)in Long run some firm will exit the market amd each firm produces at min of their AC and price=min of AC in long run

Here AC=625/Q +Q -5

Ac is minimises at 625=Q2 which implies Q=25

AC at Q=25 is 625+625-125/25=45

Thus in long run P=45 and each firm will produce Q=25

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