Question

1. XYZ company operates in a perfectly competitive market where the current market price is $10. Currently, the firm is producing 200 units at an average variable cost of $8, and average total cost of $12 and a marginal cost of $10.
   1. (2) is the situation described above a short-run equilibrium for XYZ? Explain.
   2. (2) what is XYZ's profit loss?
   3. (2) What is XYZ's producer surplus?
   4. (2) Should XYZ continue to purchase in this situation? Explain
   5. (2) Assuming that XYZ is "average" (neither more nor less efficient than other firms in the market), what would you expect to happen to market price in the long run? Explain

Answer 1

Ans.

a) Yes, in the current situation, the firm is at short run equilibrium. This is because the marginal revenue equals marginal cost which is equal to $10. Also, in short run price can be different from the average total cost.

b) Profit/Loss = (Price - Average Total Cost)*Quantity = (10 - 12)*200 = -$400

So, the firm is incurring a loss of $400

c) XYZ has zero producer surplus. This is becasue the producer surplus is the difference between the market price and marginal cost. So, this is zero for XYZ.

d) Yes, XYZ should continue to produce because the average variable cost is less than the market price. So, overall the firm may be incurring a loss but still the firm is able to cover its variable cost and a part of the fixed cost. But if the firm stopes production, then the loss will increase to full fix cost. Thus, XYZ is better off producing the good even if it is incurring losses.

e) In long run, due to losses some firms will exit the market. This will reduce the market supply of the good which will increase price in the market. This will happen till the point where the price increases to minimum value of ATC and the firms will start earning a normal profit.

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