The accompanying graph summarizes the demand and costs for a firm that operates

Question

The accompanying graph summarizes the demand and costs for a firm that operates in a perfectly competitive market.

a. What level of output should this firm produce in the short run?
b. What price should this firm charge in the short run?
c. What is the firm’s total cost at this level of output?
d. What is the firm’s total variable cost at this level of output?
e. What is the firm’s fixed cost at this level of output?
f. What is the firm’s profit if it produces this level of output?
g. What is the firm’s profit if it shuts down?
h. In the long run, should this firm continue to operate or shut down?

Explanation / Answer

a. What level of output should this firm produce in the short run? Produce the output associated with MR=MC. In this case, MR=P because the demand curve is flat. This intersection occurs at Q=7 and P=28. So, the output is 7. b. What price should this firm charge in the short run? P=28, see above explanation. c. What is the firm’s total cost at this level of output? Total cost is equal to average total cost multiplied by quantity. TC=ATC*Q According to the graph, ATC=32. TC=32*7 TC=224 d. What is the firm’s total variable cost at this level of output? Total variable cost is equal to average variable cost multiplied by quantity. VC=AVC*Q According to the graph, AVC=14. VC=14*7 VC=98 e. What is the firm’s fixed cost at this level of output? Fixed cost equals total cost minus variable cost FC=TC-VC FC=224-98 FC=126 f. What is the firm’s profit if it produces this level of output? Profit=Total Revenue-Total cost Profit=TR-TC Total revenue is the price multiplied by quantity Profit=PQ-TC Profit=28*7-224 Profit=-28 g. What is the firm’s profit if it shuts down? The firm's profit if it shuts down is the fixed cost multiplied by -1. Profit=-126 h. In the long run, should this firm continue to operate or shut down? In the long run, the firm can avoid the fixed cost. So, it should continue to operate in the short run but shut down in the long run.

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