Question

Suppose Lu operates a profit maximizing shop in a perfectly competitive market where all firms are identical. Her fixed costs are $14 per month. Her variable costs per month are given in the following table: (For simplicity, assume Lu can only produce in whole units each month)

Use the table below to fill in the missing values for total cost, average variable cost (AVC) and average total cost (ATC). Use your table to calculate the marginal cost for each additional unit of output produced per month. (2 points)

Quantity	Variable Cost	Total Cost	AVC	ATC
0	$0
1	$16
2	$22
3	$30
4	$42
5	$58
6	$78

Suppose that, in the short-run, the market price is $18 per unit. How many units would Lu produce and sell? Be sure to briefly explain how you derived your answer. How much profit will Lu earn each month?

Suppose that, instead of a market price of $18, the short-run market price is $13 per unit. How many units would Lu produce and how much profit will she earn each month? If the market price is $13, would Lu choose to operate her firm in the short-run or would she shut down? Briefly explain.

Answer 1

Q	VC	TC	AVC	ATC	MC
0	0	14
1	16	30	16	30	16
2	22	36	11	18	6
3	30	44	10	14.66667	8
4	42	56	10.5	14	12
5	58	72	11.6	14.4	16
6	78	92	13	15.33333	20

a) When P=18

The firm will set P=MC for profit maximization

so, Lu will produce 5 units

Profit = P-ATC*Q = (18-14.4)*5 = 18

b) When P=13

Lu will produce 4 units

Loss = P-ATC*Q = (13-14)*4 = -4

Lu will choose to operate in the short run rather than shutting down as the price is greater than minimum AVC so she will be able to recover her variable cost but if Lu shuts down, her loss would be equal to her fixed cost which is greater than the loss, Lu is making by continuing to operate.