1Assume a perfectly competitive firm is producing a level of output at which MR
ID: 1155477 • Letter: 1
Question
1Assume a perfectly competitive firm is producing a level of output at which MR < MC. What should the firm do to maximize its profits?
The firm should do nothing — it wants to maximize the difference between MR and MC in order to maximize its profits.
The firm should decrease output.
The firm should increase price.
The firm should increase output.
2The perfectly competitive firm:
faces a flat, perfectly elastic demand curve.
faces a downward-sloping demand function.
can influence market price only in a downward direction.
cannot earn any economic profits because it faces a horizontal demand curve.
3 When price is less than average variable cost at the profit-maximizing level of output, a firm should:
continue to produce the level of output at which marginal revenue equals marginal cost if it is operating in the short run.
continue to produce the level of output at which marginal revenue equals marginal cost if it is operating in the long run.
shutdown, because it will lose nothing in that case.
shutdown, because it cannot even cover all of its variable costs let alone its fixed costs if it stays in business.
4Horrible Gadget Company (a perfect competitor) presents the following data. The current market price is $10 per gadget. Horrible's average variable cost (at the profit maximizing quantity) is 12. What advice do you give Horrible Gadget Company?
To continue production of gadgets.
To lower the price of its gadgets.
To shut down.
To raise the price of its gadgets.
The firm should do nothing — it wants to maximize the difference between MR and MC in order to maximize its profits.
The firm should decrease output.
The firm should increase price.
The firm should increase output.
Explanation / Answer
1. Assume a perfectly competitive firm is producing a level of output at which MR < MC. What should the firm do to maximize its profits?
Answer
The firm should increase output.
The profit maximizing condition is MR=MC and the MC must intersect the MR while MC is rising. If the marginal revenue is less than the marginal cost means the MC is above the MR. In this case it must fall reaches to minimum and increase. While increasing it must intersect the MR to get the profit maximizing output. For this process and to reach to the profit maximizing output the firm should increase the output.
2. The perfectly competitive firm:
Answer
Faces a flat, perfectly elastic demand curve
In perfect competition market the average revenue is equal to marginal revenue and that is also the demand curve. So the demand curve will be perfectly elastic represented by straight horizontal line.
3. When price is less than average variable cost at the profit-maximizing level of output, a firm should:
Answer
Shutdown, because it cannot even cover all of its variable costs let alone its fixed costs if it stays in business.
If the price is less than the average variable cost the firm should shut down because the firm is not able to recover the variable cost. In this case the loss will be more than the fixed cost. Hence, the firm should shut down and incur the loss equal to fixed cost.
4.Horrible Gadget Company (a perfect competitor) presents the following data. The current market price is $10 per gadget. Horrible's average variable cost (at the profit maximizing quantity) is 12. What advice do you give Horrible Gadget Company?
Answer
To shut down
If the price is less than the average variable cost the firm should shut down because the firm is not able to recover the variable cost. In this case the loss will be more than the fixed cost. Hence, the firm should shut down and incur the loss equal to fixed cost.
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