Question

You are given the following information for a producer of organic grommets in a perfectly competitive market TFC = $8 Market price = $9 Quantity M C (5) 27 5 10 The marginal cost of production appears in the table above. What is the profit-maximizing output? Is the firm making a profit or loss? How much? Output (Click to select)

Answer 1

Quantity

In a perfectly competitive market, profits are maximized at the quantity where price equals marginal cost.

Since, the quantities here are discrete, rather than increasing smoothly,we select the quantity, where the MC is closest to the price, without exceeding the price. However, this condition is satisfied at Q=1 and at Q=4, where the MC=8. However, production does not stop at Q=1, since the marginal cost falls in subsequent stages. Hence, it does not make sense to stop production here. Thus, the profit maximizing output here is 4.

Profit/Loss

When, the firm is producing 0 units, it still has to incur the fixed cost, hence at Q=0, Total cost= $8

For Q=1, total cost= 8+MC= 8 + 8= $16 (Since, Marginal cost, by definition is the additional cost that needs to be incurred for producing an additional unit of the commodity).

Similarly, for Q=2, Total Cost = 16+7= $23

Hence at Q=4, Total Cost = 23+6+8= $ 37

Now, the firm's total revenue = Price * Quantity = $9*4= $ 36

Thus, at Q=4, the firm is making a loss of 37-36= $1