Question

2. Table 4 below shows the total output, total revenue, total variable cost, and total fixed cost of a perfectly competitive firm. The market equilibrium price is not given explicitly but can be deduced from Table 4. Output lulewin Total revenue $1,500 $2,000 $3,000 $4,000 $5,000 Total variable cost $1,500 $2,000 $2,600 $3,900 $5,000 Total fixed cost $500 $500 $500 $500 $500 a. What level of output should the firm produce? Show your work. (15 points) b. Should it shut down in the short run? Explain. (10 points) c. Should it exit the industry in the long run? Explain. (10 points)

Answer 1

a.

TR 1 2 TVC TEC P 1500 500 2000 500 2600 500 3900 500 5000 500 1500 2000 3000 4000 5000 AVC MCTCProfit 1500 1500 1500 2000 -500 1000 1000 500 2500 -500 1000 866.667 600 3100 - 100 1000 975 1300 4400 -400 1000 1000 1100 5500 -500 3

The profit-maximizing condition of perfectly competitive firm is

P=MC

Or

P>MC

Hence according to the given condition, profit-maximizing or loss minimizing quantity is

3 units.

TR=P*Q

Hence price for each units will be $1000.

b.

Since the shut-down condition is

P=minimum of AVC

Since price is greater than minimum of AVC at quantity of 3 units. Hence firm should produce quantity rather than shut down because loss is minimized at quantity of 3 units.

c.

Since in the short-run firm is making loss of $100, so firm should exit industry because in the long-run all factors are variable while in the short-run some factors are fixed and some are variable inputs.