Suppose that marginal revenue for a perfectly competitive firm is $20 . When the

Question

Suppose that marginal revenue for a perfectly competitive firm is $20 . When the firm produces 10 units, its marginal cost is $20, its average total cost is $22, and its average variable cost is $17. Then to maximize its profit in the short run, the firm


a. should not change its production because it is already maximizing its profit and is earning a normal profit.

b. must decrease its output to increase its profit.

c. should stay open and incur an economic loss of $20.

d. should shut down.

e. must increase its output to increase its profit.

Explanation / Answer

Marginal revenue = price, so the price per unit is $20. Thus, the total revenue is price * quantity = 20 * 10 = $200. The total cost is equal to average total cost * quantity = $220, and the total variable cost = average variable cost * quantity = 17 * 10 = $170. Since the total revenue is greater than the total variable cost, the firm should keep producing in the short-run. However, they will incur a loss of total revenue - total cost = 200 - 220 = $20. Thus, the answer is c, the firm should stay open and incur an economic loss of $20.

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