Question

Assume the market price for a good is $15, and the fixed costs of a perfectly-competitive producer is $200. Also assume that if the firm decided to operate, its profit-maximizing (or loss minimizing) output would be 30 units, its total variable cost would be $400, and its revenue would be $450 (=$15x30). a. How much would the firm’s profits be? Show your work. b. Would the firm choose to operate in the short-run? Why or why not? c. Would the firm choose to operate in the long-run? Why or why not?

Answer 1

a). Profits = Total revenue - Total cost.

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The total cost is the sum of both the total variable cost and the total fixed cost.

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Profits  

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The firm is earning negative economic profits or making loss.

b). A firm would shutdown its activities if the price is below the average variable costs, in the perfect competition the market price is also equal to the marginal and average revenue. So if the price falls below AVC , the firm would not able to cover its variable cost so they shutdown. In this situation the price is $15 and it is above the average variable cost and the firm will continue to produce in the short run.

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c). In the long run every firm earns at least zero economic profit, that is firm is break even , total costs equals to total revenue. So if the price is below the ATC the firm is still making loss and it should exit in the long run because all other firms would be earning the zero economic profits.

The firm will need at least zero economic profit in the long run to sustain, so this firm will exit in the long run