Practice Questions 4

3,000 to 3,500

Firms, in their attempt to maximize profits, will choose the plant size that minimizes the per-unit cost of producing whatever output level is chosen. For our hypothetical firm in this problem, if it chooses to produce in the output range of 4,000-5,000 units, the plant size corresponding to ATC-3 yields the lowest per-unit cost.

Greater than $10/unit

Returns to scale (economies, diseconomies, constant) refer to how long run average costs change in response to input changes of equal proportions. If a firm is currently experiencing economies of scale, increasing all of its inputs by the same proportion will lead to a reduction in per unit costs. A firm experiencing economies of scale and a production cost of $12 per unit will see that per unit cost fall when it increases (e.g. doubles) its inputs.

total cost is $910

Total cost can be found by multiplying the quantity produced by the average total cost (ATC). If not explicitly given, the ATC can be found by summing the average variable cost (AVC) and average fixed cost (AFC). If, for example, AVC = $20 and AFC = $6, then ATC = $26 (= 20 + 6). Taking ATC times the total output of 35 gives a total cost of $910 (= $26 × 35) .

$16

Average total costs (ATC) can be calculated as total cost divided by the quantity of output. If, for example, total cost is 48 and output is 3, then ATC is $16 (= $48/3).

monopolistic competition

The four market structures (pure competition, monopolistic competition, oligopoly, and pure monopoly) are classified by the number of firms in the industry, the degree of control any individual firm has over price (as represented by its share of the total market), and whether the product is standardized or differentiated. If, for example, 40 firms each control only 2-3 percent of the market for a differentiated product, that meets the criteria for monopolistic competition.

$240

In a purely competitive market, because the firm is a "price taker," the marginal revenue from selling an additional unit is constant at the market price. Total revenue is found by multiplying the quantity of output by the market price, so the price can be found by dividing the total revenue by the number of units sold. If, for example, 10 units are sold, generating a total revenue of $200, then the market price is $20 (= 200/200). If 12 units are sold at $20, total revenue is $240 (= 10 × 20).

Harry's should stay open in the short run.

A firm should produce in the short run if it is earning economic profits, breaking even (just covering its costs) or earning enough to cover all of its variable costs. If, for example, Harry’s has total revenue of $5,000/week, total variable cost of $2,600/week, and total fixed cost of $2,400, it is experiencing an economic loss of $0 [= 5,000 − (2,600 + 2,400)]. If that loss is smaller than its fixed cost of $2,400 (how much the firm would lose if it shut down), Harry’s is better off stay open in the short run.

is realizing an economic Profit of $40.

Profit or loss is calculated as total revenue minus total cost. Total revenue is found by multiplying price times quantity sold. Total cost is the sum of total fixed cost and total variable cost. In this problem, total fixed cost is given and total variable cost is found by multiplying average variable cost by the number of units produced. The firm produces and sells 20 units at the market price of $10, its total revenue is $200 (= 20 × $10). If its fixed cost is $100 and its average variable cost for producing 20 units is $3 per unit, then its total cost is $160 (= $100 + ($3 × 20)). Profit therefore is $40 (= 200 − 160).

3

With the marginal revenue = marginal cost approach a firm maximizes profit by selling up to the point where MR = MC. If there is no output level where they precisely equal, the firm should produce as long as MR > MC and stop selling before reaching a point where MR falls below MC. Using the MR = MC rule to find the profit-maximizing output assumes that price is above the minimum of average variable cost (AVC), otherwise there is no positive amount of output that yields a greater profit or smaller loss than simply shutting down in the short run. If, for example, marginal revenue is $16 and the minimum AVC is $10, the firm is better off producing. If the MC at 2, 3, and 4 units of output are 9, 13, and 17, respectively, the firm should produce the second unit (16 > 9), produce the third unit (16 > 13), but stop before producing the fourth unit (16 < 17). So the profit-maximizing output would be 3 units of output.

continue producing, but reduce output.

As long as the market price is above minimum average variable costs, the firm should produce, as any loss will be smaller than shutting down. Assuming the firm should produce, if MR = MC at its current level of output, it should continue to produce that level of output. If MR > MC, it should expand production; if MR < MC, it should reduce output. If, for example, the market price is $8.80, marginal and average total cost are both $10.50, and average variable cost is $6.50, the firm should continue producing, but reduce output.

Shut Down

As long as the market price is above minimum average variable costs, the firm should produce, as any loss will be smaller than shutting down. Assuming the firm should produce, if MR = MC at its current level of output, it should continue to produce that level of output. If MR > MC, it should expand production; if MR < MC, it should reduce output. If, for example, the market price is $3.50 marginal cost is $6.00, and minimum average variable cost is $4.00, the firm should shut down..

continue production, but reduce output.

As long as the market price is above minimum average variable costs, the firm should produce, as any loss will be smaller than shutting down. Assuming the firm should produce, if MR = MC at its current level of output, it should continue to produce that level of output. If MR > MC, it should expand production; if MR < MC, it should reduce output. If, for example, the market price is $3.20, marginal cost is $3.80, and minimum average variable cost is $2.30, the firm should continue production, but reduce output.

9 units and earn economic profits of $1,071.

As long as the market price is above minimum average variable costs, the firm should produce. The profit-maximizing firm produces to the level of output where MR = MC. (or, as long as MR > MC, but stopping short of producing where MR < MC). Once the profit-maximizing output level has been determined, total revenue is equal to that output times the market price. Total cost is found by multiplying ATC by output. The difference between total revenue and total cost is the economic profit (or loss, if the number is negative).

Price must be at least equal to average total cost.

(Price times quantity produced must be equal to or greater than total variable cost for some level of output or the firm will close down in the short run. Price may be equal to, greater than, or less than average total cost. Price must be equal to or greater than minimum average variable cost for the firm to continue producing.)

continue producing, but reduce output.

As long as the market price is above minimum average variable costs, the firm should produce, as any loss will be smaller than shutting down. Assuming the firm should produce, if MR = MC at its current level of output, it should continue to produce that level of output. If MR > MC, it should expand production; if MR < MC, it should reduce output. If, for example, the market price is $6.00, marginal and average total cost are both $8.00, and average variable cost is $5.00, the firm should continue producing, but reduce output.

between P2 and P3. (between AVC and AVT Curves)

the bcd segment and above on the MC curve.

Lowest point of AVC curve and up.