\"The demand and cost estimates that were provided at the meeting are very usefu
ID: 1223136 • Letter: #
Question
"The demand and cost estimates that were provided at the meeting are very useful [Q =160 - 8P and TC = 150 + 10Q]. Unfortunately, what we didn't realize at the time was that our fixed costs were underestimated by at least 50 percent. This means that we'll have to adjust our price upward by at least 50 percent to cover the added fixed cost. In any case there is no way in the world we can survive by charging less than $22.50 for our product." A) COMMENT on this statement. Do you agree with the speaker? Explain. B) WHAT price and quantity do you think this firm should charge and produce if it wants to maximize it's short-run profit? Explain.
Explanation / Answer
The Profit maximization condition of the firm in the short run is given by equalizing marginal Cost of the firm with the Marginal Revenue of the firm. It is stated that the firm should charge a price equal to above the minimum point of the average variable cost curve. Thus, it should be able to cover its variable cost. Even if the firm is unable to cover its Fixed cost. it is not a matter of concern as the firm will have to incur losses equal to Total Fixed Cost of the firm if it shuts down.
So, if TFC is increased, then it is not mandatory for the firm to increase its prices.
To maximize its short tun profits, the firm should equalize its Marginal revenue with its Marginal Cost.
Q = 160 - 8 P
P = 160 - Q / 8 = 20 - 0.125 Q
P = 20 - 0.125 Q
TR = 20 Q - 0.125 Q ^2
MR = 20 - 0.25 Q
MC = 10
20 - 0.125 Q = 10
Q = 40 units
P = 20 - 0.125 * 40 = $15.
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