. In a perfectly competitive industry, the market price is $25. A firm is curren
ID: 1251573 • Letter: #
Question
. In a perfectly competitive industry, the market price is $25. A firm is currentlyproducing 10,000 units of output, its average total cost is $28, its marginal cost is
$20, and its average variable cost is $20. Given these facts, explain whether the
following statements are true or false:
a. The firm is currently producing at the minimum average variable cost.
b. The flrm should produce more output to maximize its profit.
c. Average total cost will be less than $28 at the level of output that maximizes the
firm's profit.
(Hint: You should assume normal U-shaped cost curves for this problem. )
Explanation / Answer
A. At the minimum average variable cost, marginal revenue equals average variable cost. Since these both equal 20 in this example, this statement is correct. B. In a perfectly competitive market, price is equal to marginal revenue. Since marginal revenue is 25 and marginal cost is only 20, the firm should produce more output to increase marginal cost to 25 and maximize profit. This is also a correct statement. C. This is also true. When profit is at a maximum, marginal revenue equals marginal cost. In this case, they will both equal 25. Since this is below 28, the average total cost will be below 28 at the profit maximum. That is, the marginal cost is lower than the average total cost when the average total cost is decreasing, equal to average total cost when average total cost is at a minimum, and greater than average total cost when average total cost is increasing. The average total cost is 28, which means it is decreasing because the marginal cost is only 20. The profit maximizing marginal cost is 25. So, it will still be decreasing at the profit maximizing point.
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