A perfectly competitive firm faces a market-determined price of $25 for its prod

Question

A perfectly competitive firm faces a market-determined price of $25 for its product.

a.The firm’s total costs are given in the schedule above. Fill in columns 3 and 4 for average total cost and marginal cost.

b. Fill in columns 5 and 6 for marginal revenue and profit margin.

c. How much output should the competitive firm produce? Explain.

d. Label column 7 “Total profit” and fill in the values. Is your answer to part c correct? Explain.

e. Suppose the demand for the firm’s product decreases and the market price falls to $14. Should the firm shut down? If not, how much output should the firm produce? Explain.

(1) (2) (3) (4) (5) (6) (7) Quantity Total Cost Average Total Cost Marginal Cost Marginal Revenue Profit Margin Total Profit (d) 0 1,000 100 2,000 200 3,300 300 4,800 400 7,000 500 9,600

Explanation / Answer

A. ATC = TC/Q

MC = change in total cost/change in output.

b. For marginal revenue we first need to calculate the total revenue.

TR = price*quantity.

MR = change in total revenue due to change in output.

For profit margin we first need to compute the total profits,

Profit = total revenue - total cost.

Profit margin = profit/total revenue.

c. Profit maximising level of output for a competitive firm is where its P = MR = MC. This is at 500 units of output.

(MC at 500 units is $26, since this is the nearest value, so we'll consider this as the profit maximising level of output).

d. Answer to part c is correct because a firm in the competitve industry cannot sustain high profits for long. Ultimately, the profits drops to the normal profits in the long run.

e.

Q TC ATC MC TR MR PROFIT PROFIT MARGIN 0 1000 NIL NIL 0 NIL -1000 NIL 100 2000 20 10 2500 25 500 20% 200 3300 16.5 13 5000 25 1700 34% 300 4800 16 15 7500 25 2700 36% 400 7000 17.5 22 10000 25 3000 30% 500 9600 19.2 26 12500 25 2900 23%

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