The figure above represents Giuliani’s farm a profit-maximizing perfectly compet

Question

The figure above represents Giuliani’s farm a profit-maximizing perfectly competitive firm with the price of its product been equal to $7. Explain your answers.

a) How much will the firm produce?

b) How much is the firm's average total, average variable, and marginal costs?

c) How much is the firm's total, total variable, and total fixed costs?

d) How much is the firm's total revenue and economic profit?

e) What will happen in this market in the long run?

Explanation / Answer

The profit maximizing condition for a perfectly competitive market is at P = MC. That means a perfectly competitive firm will produce profit maximizing output where price equals marginal cost of production.

a. Here P is $7, so firm will produce 40 units as at that level of output P = MC condition holds.

b. At 40 units of output, firm's ATC is $4 and AVC is $3. Because corresponding to price $7 if we draw a straight line to point out the amount of quantity, then the straight line will intersect the ATC curve at $4 and cuts AVC curve at $3. And due to P =MC, Marginal cost is $7.

c. Firm's total cost = (Quantity * ATC) = (40 * $4) = $160.

Firm's total variable cost = (Quantity * AVC) = (40 * $3) = $120.

Then firm's total fixed cost = Total Cost - Total variable cost = $160 - $120 = $40.

d. Firm's Total revenue = (Quantity * Price) = (40 * $7) = $280.

Firm's Profit = (Total revenue - Total Cost) = $280 - $160 = $120.

e. In the long run, new firms will enter the market due to positive economic profit in the market. As a result, supply will rise, which will reduce the level of price from $7 to $4. As a result there will be no positive economic profit and there will be no incentive for new firms to enter the market.

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