3. The components of marginal revenue Lorenzo\'s Fire Engines is the sole seller
ID: 1153708 • Letter: 3
Question
3. The components of marginal revenue Lorenzo's Fire Engines is the sole seller of fire engines in the fictional country of Pyrotania. Initially, Lorenzo produced four fire engines, but he has decided to increase production to five fire engines. The following graph shows the demand curve Lorenzo faces. As you can see, to sell the additional engine, Lorenzo must lower his price from $105,000 to $90,000 per fire engine. Note that while Lorenzo gains revenue from the additional engine he sells, he also loses revenue from the initial four engines because he sells them all at the lower price. Use the purple rectangle (diamond symbols) to shade the area representing the revenue lost from the initial four engines by selling at $90,000 rather than $105,000. Then use the green rectangle (triangle symbols) to shade the area representing the revenue gained from selling an additional engine at $90,000. Revenue Lost Demand Revenue Gained È % % PRICE (Thousands of dollars per fire engine) % % O 0 1 2 8 9 10 3 4 5 6 7 QUANTITY (Fire engines)Explanation / Answer
lorenzo's should not increase production from 4 to 5 fire engines because output effect his total revenue.
reason: By lowering the price at which each unit is sold, the price change has a negative effect on total revenue. This is the price effect. Yet more units are sold when the price decreases, which has a positive effect on revenue. This is the output effect. In this case, as output rises, the price effect dominates the output effect, leading to lower total revenue.
false
because an individual firm can sell as much output as it wants at the market price, it would be unprofitable for it to sell at any price below the market price. Therefore, lowering its price from $100,000 to $90,000 would not result in either increased output or increased revenue
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