A chemical firm that is a price taker is currently producing 100 units of output

Question

A chemical firm that is a price taker is currently producing 100 units of output per day with MC = $8, AVC = $7 and ATC = $9. The prevailing market price of the product is $8.50. In order to maximize short-run profits (or minimize short-run losses if that is the best the firm can do), the firm should a. increase its selling price to some point above $9 b. increase its output until MC equals $8.50 c. shut down production in the short-run because it is losing money d. reduce its output so as to lower its MC, AVC and ATC and thereby earn an economic profit

Explanation / Answer

A chemical firm that is a price taker is currently producing 100 units of output per day with MC = $8, AVC = $7 and ATC = $9. The prevailing market price of the product is $8.50. In order to maximize short-run profits (or minimize short-run losses if that is the best the firm can do), the firm should a. increase its selling price to some point above $9 [This is incorrect because the firm is a price-taker, so cannot raise price] b. increase its output until MC equals $8.50 [This is correct because of the golden rule of profit maximization, increase production until MC=MR=P (for price-takers). If it costs us $8 to produce the last unit and it makes us $8.50, then that last unit was profitable, so we should make more units until MC=P and the next unit we produce will not make us any more profit.] c. shut down production in the short-run because it is losing money [This is incorrect because when price is greater than AVC, we do not shut-down in the short-run. This is because we are covering some of the fixed costs and would not be covering any fixed costs if we shut-down] d. reduce its output so as to lower its MC, AVC and ATC and thereby earn an economic profit

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