A profit-maximizing firm is producing where MR = MC and has an average total cos

Question

A profit-maximizing firm is producing where MR = MC and has an average total cost of $4, but it gets a price of $3 for each good it sells.

a. What would you advise the firm to do?

b. What would you advise the firm to do if you knew average variable costs were $3.50?

The firm is producing where MR = MC, so it should produce in both the short run and long run. The firm should shut down in the short run and exit the market in the long run. The firm should shut down in the short run. Once the firm recoups its fixed costs, it should produce in the long run. As long as average variable costs are less than $3, in the short run, the firm should produce. In the long run, it should exit the market.

Explanation / Answer

a - 4

This is because in short run we produce as long as variable costs are covered as gives a scope of a portion of ixed costs being covered. In the long run since all costs are variable, the failure to recover the cost shall lead to a loss making the firm exit.

b - 1
The firm is unable to even recover the variable cost in the short run, hence it should shut down and even exit in the long run, as all costs are variable in the long run. The firm should produce as long as the fixed costs are being recovered.

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