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Suppose that a perfectly competitive firm faces a market price (P) $5 per unit, and at this price the upward-sloping portion of the firm’s marginal cost curve crosses its marginal revenue curve at an output (Q) level of 1,500 units. If the firm produces 1,500 units, its average variable costs (AVC) equal $5.50 per unit, and its average fixed costs (AFC) equal 50 cents per unit. What is the firm’s profit-maximizing (or loss minimizing) output (Q) level? What is the amount of its economic profits (or losses) at this output level? What would be the firm's decision at this price/output level?

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Answer:

What is the firm’s profit-maximizing (or loss minimizing) output (Q) level?

  • the profit maximizing output level is 1,500 because at this point the price = marginal cost

What is the amount of its economic profits (or losses) at this output level?

at the current output level (1,500 units), the company is losing $1,500: (1,500 x $6) - (1,500 x $5) = $9,000 - $7,500 = $1,500

What would be the firm's decision at this price/output level?

  • they should stop production and exit the market since variable costs ≥ selling price

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