Question

A competitive firm is currently selling its product at a price of $5.00 per unit. At...

A competitive firm is currently selling its product at a price of $5.00 per unit. At

its current output the firm estimates that its average cost of production is $6 and its average fixed

cost is $3. In the short-run what should this firm do? WHY? Support your answer with a graph.

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Homework Answers

Answer #1

Since the profit-maximising condition of the perfectly competitive firm is

P=MC

The firm shut-down point exist where

P=MC=AVC

Since the given output

ATC=6

AFC=3

AVC=ATC-AFC

=6-3

=3

Since price is $5 and AVC cost is $3, it means firm is able to cover full variable cost but also able to cover some fixed cost. It means by producing the firm will minimise its loss but if it shut down, loss will be more and it will be equal to the total fixed cost.

All this has been shown in the below diagram.

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