Question

Consider a firm operating in a perfectly competitive market. At its current output of 200 units, marginal revenue is $28. At this output, average total cost is minimized and equals $25. Given this information, what should the firm do?

a. Continue to produce 200 units, since costs per unit are minimized

b. Increase output beyond 200 units, since this higher output will yield the profit maximizing output level.

c. Decrease output below 200 units, since this lower output will result in the profit maximizing output level.

d. More information is needed to determine the firm’s next step.

Answer 1

Option B.

• Given that a firm is operating within a perfectly competitive market.
• When it's current output is 200 units it earns a marginal revenue of $28.
• The average total cost falls below the marginal revenue and is just $25.
• As the firm earns higher revenue than it incurs costs, it must increase its production beyond 200 units.
• This will allow the firm to earn higher profits by producing additional units of that output.
• A point is reached when it's marginal revenue will equal it's marginal cost when it increases output beyond 200 units.
• At this point, the firm will yield the profit maximizing output level.