1) For each of the following statements, identify them as true or false and brie
ID: 1107969 • Letter: 1
Question
1) For each of the following statements, identify them as true or false and briefly explain your reasoning. If a firm in a perfectly competitive market receives a price greater than its average variable cost but less than its average total cost then the firm will earn negative economic profit and should shut down in the short-run. (2 points) a. b. A profit maximizing firm in a perfectly competitive market where all firms are identical has an incentive to lower its price below the market clearing price.(2 pointsExplanation / Answer
Question 1
(a)
If a firm in a perfectly competitive firm receives a price that is less than its average total cost then this implies that its total revenue is not sufficient to recover all its costs and thus it earns a negative economic profit.
However, whether the firm will shut down or not in short-run depends on recovery of variable cost.
If firm is able to recover its variable cost or price is greater than average variable cost then firm will remain in operation in short-run.
On the other hand, if firm is not able to recover its variable cost or price is less than the average variable cost then firm will shut down in the short-run.
In given case, price is greater than the average variable cost.
So, firm will remain in operation, even though, it is earning negative economic profit.
Hence, the given statement is False.
(b)
A firm in a perfectly competitive market acts as price taker.
It has to accept the price. The reason for this is that product sold by each firm in perfectly competitive market are identical. So, if a firm reduces price in such scenario then it would not be able to gain from it as in absence of differentiation, consumers would not be able to recognize the product and thus firm would would not gain by lowering the price.
Thus, there would be no incentive for perfectly competitive firm to lower its price below the market clearing price.
Hence, the given statement is False.
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