Question

Given the following information about a firm under perfect competition, the price of the product is $40

Rate of output	Total Cost	Marginal Cost	Total Revenue	Marginal Revenue	Average Total cost	Average variable cost
0	60		0
1	80	20	40	40	80	20
2	120	40	80	40	60	30
3	180	60	120	40	60	40
4	260	80	160	40	65	50
5	360	100	200	40	72	60

    b- What is the profit-maximizing rate of output? Should the firm stay in the business? At which price should the firm shut down?

Answer 1

The profit maximizing rate of output in case of a perfectly competitive economy is the one at which P= MC. Here P= 40. MC= 40 when Q= 2. Hence Q=2 is the profit maximizing rate of output.

The shut down point for a firm is the price at which the firm is indifferent between producing or not producing. It is given when P= min AVC. Because at this price, if the firm produces, it will only be able to cover its variable costs and not fixed costs and if it doesn't then also it will lose its fixed costs. Hence it is indifferent between producing and not producing.

If the price is such that it is below min of AVC then firm will shut down as it's not able to cover the variable costs aa well and if price is greater than min of AVC then firm will continue to be in business.

Here, min of AVC is 20 . This will be the shut down point for firm i.e. P=20, Q= 1.

Given P=40 which is greater than 20 , therefore the firm will continue to be in business.