Question

You are the manager and selling your product in a perfectly competitive firm market. Your firm and other firms sell the product at a price of RM 90. Your cost function is C(Q) = 50 + 10Q + 2 Q².

1. What level of output should you choose to maximize profits?
2. What are your firm’s short run profits?
3. What will happen in your market in the long run? Explain.

Answer 1

C(Q) = 50 + 10Q + 2 Q², thus MC = 10+4Q (1st derivative of cost function)

Price = AR = MR = 90 (perfectly competitive market)

i) To maximize profits, MC should be equal to MR

10+4Q= 90

Q= 20.

The firm must produce 20 units of output.

ii) Short run cost for producing 20 units is

C(Q) = 50 + 10Q + 2 Q²= 50+10*20+2*20²= 50+200+800= 1050

Total revenue = 20*90 = 1800

Short run profit = TR-TC = 1800-1050= 750.

iii) Here the firm is making supernormal profits in the short run, this will induce other firms to enter into the market. When other firms enters the supply in the market increases and this will reduce the price of the product and reduce the profits earned by the firms. Eventually in the long run every firms will earn only normal profits or zero economic profits.