A perfectly competitive firm\'s average fixed cost function is AFC = 20/Q, its a

Question

A perfectly competitive firm's average fixed cost function is AFC = 20/Q, its average variable cost function is AVC = 2 + 0.2Q, and it marginal cost function is MC = 2 + 0.4Q. The firm optimizes by producing the level of output that maximizes profit or minimizes loss. If the market price of the good is P = $1, then the firm will:

a.) produce 20 units of output and earn a profit of $0
b.) produce 20 units of output and earn a profit of $20
c.) produce 10 units of output and suffer a loss of $40
d.) produce 10 units of output and suffer a loss of $20
e.) produce 0 units of output (shut down) and suffer a loss of $20

Explanation / Answer

Answer
option e
The AVC at Q=1 is
=2+0.2*1=2.2
the AVC>P at any value of output so the firm will shut down and minimize losses which losses are equal to fixed cost
fixed cost=AFC*Q=(20/Q)*Q=20

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