Question 1. Suppose you are a consultant for a firm that is perfectly competitiv

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Question 1. Suppose you are a consultant for a firm that is perfectly competitive. The firm is worried only about its policies in the short run. What would you recommend in terms of quantity changes (raise, cut, shut down or stay put) and price changes (raise, cut, stay put) in each of the following situations:

a. [10 points] P = $19   MC = $14 AVC = $20
b. [10 points] P = $111 MC = $106 AVC = $107  

Question 2. Suppose you are working as a consultant for a firm that is a monopoly and is worried about its policies in the short run. What would you recommend in terms of quantity changes (raise, cut, shut down or stay put) and price changes (raise, cut, stay put) in each of the following situations:

a. [10 points] P = $299 MC = $349   AVC = $319
b. [10 points] MR = $150 MC = $100   AVC = $140
c. [10 points] MR = $288 MC = $338   AVC = $278  

[Note: P = price; MR = marginal revenue; AVC = average variable cost; MC = marginal cost]

Explanation / Answer

1) (a) Price - stay and Quantity - stay

Under perfect competition, firms are price takers and they do not have any control over the price of commodity. So, price of commodity will remains the same. Since, firm is not able to average variable cost so firm suffers loss of $ 1 but in short run firm will stay in hope that earning in future will increase. Since, P > MC which means that cost of additional output is less than the price which firms get on the sale of it.

(b) Price - stay and Quantity - more

Under this situation, firm is able to cover its variable cost which means firm is earning profit. But since, firms are price takers so price will stay at the same rate while quantity will increase.

2) (a) Loss to a firm because additional cost is more than the price charged by the monopoly firm. So, price will increase and quantity will decrease.

(b) For equilibrium, MR = MC and when MR > MC producing more units will increase profit because increase in unit will decrease the gap between MR and MC.

So, quantity will increase and price will increase.

(c) When MR < MC, in this producing one less unit will decrease cost per additional unit and due to this profit increases.

So, quantity will decrease and price will increase.

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