Question

A perfectly competitive firm in the puzzle market has fixed costs that are sunk in the short run. The current situation facing that perfectly competitive firm is described by

: (i) MC intersects ATC at $20 / puzzle.

(ii) MC inteects AVC at $10 / puzzle.

(iii) The market price of puzzles is $15 / puzzle.

Which of the following statements is (are) true?

I. This firm makes negative economic profit in the short run.

II. This firm’s profits will increase if it shuts down.

III. Firms will exit this puzzle market in the long run.

( a) I, II, and III

(b ) I and III only

(c ) II and III only

(d ) I only

Answer 1

Ans. b) I and III only

Since P < ATC ( i. e. $15/ puzzle <$20/ puzzle), therefore, this firm makes negative economic profit in the short - run.

In the long run, firm will produce where P = min ATC where this firm will recover the fixed cost and variable cost and will exit the puzzle market because it has negative economic profit in the short run.

If P = minAVC that is a shut down point becaue if price will fall below the min AVC then firm will not able to recover the variable cost from the revenue and it will immediatelyidiately shut down the production.