Given below are the cost schedules for a perfectly competitive firm. Average Ave
ID: 1177148 • Letter: G
Question
Given below are the cost schedules for a perfectly competitive firm.
Average Average
Variable Total Marginal
Quantity Cost Cost Cost
1 $ 50 $ 90 $ 50
2 45 65 40
3 40 53 30
4 35 45 20
5 34 42 30
6 35 41 40
7 37 43 50
8 40 45 60
a) At a product price of $ 40, how many units will this firm produce in the short-run? EXPLAIN. What will be its profits or losses?
b) At a product price of $ 50, how many units will this firm produce in the short-run?
EXPLAIN. What will be its profits or losses?
c) At a product price of $ 60, how many units will this firm produce in the short-run?
EXPLAIN. What will be its profits or losses?
Explanation / Answer
Given below are the cost schedules for a perfectly competitive firm.
Average Average
Variable Total Marginal
Quantity Cost Cost Cost
1 $ 50 $ 90 $ 50
2 45 65 40
3 40 53 30
4 35 45 20
5 34 42 30
6 35 41 40
7 37 43 50
8 40 45 60
a) At a product price of $ 40, how many units will this firm produce in the short-run? EXPLAIN. What will be its profits or losses?
In a perfectly competitive market, each individual firm has to take the price as exogenously given since it is too small to influence the price.
Hence each firm can sell as much as it wants at the given market price. If any firm charges a higher price then it will lose all its buyers since there exists infinitely many firms who sell the identical good at the lower market price. And no firm will want to charge a lower price since it can sell as much as it wants at the given market price.
Hence each unit is sold for the same market price, i.e. MR=P.
Profits are maximized when the marginal revenue, MR equals the marginal cost, MC,
i.e. MR=MC=P. Here P=$40. There are two quantity levels when MR=MC=P=40. At Q=2, profits are minimized since for any additional quantity produced, the price which is equal to the marginal revenue exceeds the marginal cost of production. Thus, each additional unit adds more to revenue than to cost, i.e. profits increase with each additional unit. Hence the profit maximizing quantity is 6 units.
Profits = TR %u2013 TC = (P*Q) %u2013 (ATC*Q) = Q(P-ATC) =6*(40-41) = -$6.
Hence the firm minimizes its losses at $6 by producing 6 units of the good.
This occurs in the short run. In the long run, the presence of losses will induce the exit of firms out of the market, reducing supply and hence increasing the market price till the loss of each of the remaining firms in the industry are reduced to zero, i.e. each firm earns normal profits. In the short run, the firm will choose to operate and minimize its losses, since the price of $40 covers the average variable cost of $35 an d also part of the fixed costs. If the firm shuts down in the short run then it will incur the whole of fixed costs as loss.
b) At a product price of $ 50, how many units will this firm produce in the short-run?
EXPLAIN. What will be its profits or losses?
In a perfectly competitive market, each individual firm has to take the price as exogenously given since it is too small to influence the price.
Hence each firm can sell as much as it wants at the given market price. If any firm charges a higher price then it will lose all its buyers since there exists infinitely many firms who sell the identical good at the lower market price. And no firm will want to charge a lower price since it can sell as much as it wants at the given market price.
Hence each unit is sold for the same market price, i.e. MR=P.
Profits are maximized when the marginal revenue, MR equals the marginal cost, MC,
i.e. MR=MC=P. Here P=$50. There are two quantity levels when MR=MC=P=50. At Q=1, profits are minimized since for any additional quantity produced, the price which is equal to the marginal revenue exceeds the marginal cost of production. Thus, each additional unit adds more to revenue than to cost, i.e. profits increase with each additional unit. Hence the profit maximizing quantity is 7 units.
Profits = TR %u2013 TC = (P*Q) %u2013 (ATC*Q) = Q(P-ATC) =7*(50-43) = $49.
Hence the firm maximizes its profits at $49 by producing 7 units of the good.
This occurs in the short run. In the long run, the presence of positive profits will attract the entry of new firms into the market, expanding supply and reducing the market price till the profit of each firm in the industry is reduced to zero, i.e. each firm earns normal profits.
c) At a product price of $ 60, how many units will this firm produce in the short-run?
EXPLAIN. What will be its profits or losses?
In a perfectly competitive market, each individual firm has to take the price as exogenously given since it is too small to influence the price.
Hence each firm can sell as much as it wants at the given market price. If any firm charges a higher price then it will lose all its buyers since there exists infinitely many firms who sell the identical good at the lower market price. And no firm will want to charge a lower price since it can sell as much as it wants at the given market price.
Hence each unit is sold for the same market price, i.e. MR=P.
Profits are maximized when the marginal revenue, MR equals the marginal cost, MC,
i.e. MR=MC=P. Here P=$50. MR=MC=P=60 at Q=8. Hence the profit maximizing quantity is 7 units.
Profits = TR %u2013 TC = (P*Q) %u2013 (ATC*Q) = Q(P-ATC) =8*(60-45) = $120.
Hence the firm maximizes its profits at $120 by producing 8 units of the good.
This occurs in the short run. In the long run, the presence of positive profits will attract the entry of new firms into the market, expanding supply and reducing the market price till the profit of each firm in the industry is reduced to zero, i.e. each firm earns normal profits.
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