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In yet another competitive industry, the market-determined price is $10
In yet another competitive industry, the market-determined price is $10. For a firm currently producing 250 units of output, short-run marginal cost is $7, average total cost is $39, and the average variable cost is $9. This firm incurs total quasi-fixed costs of $2,500, thus average quasi-fixed cost is $10 per unit. Is this firm making the profit-maximizing decision? Why or why not? If not, what should the firm do? (Hint: You will need to compute total avoidable cost.)
Expert Solution
Total Revenue = Price * Quantity
=> Total Revenue = 10 * 250 = 2500
Total Cost = Average Total Cost * Number of units produced
=> Total Cost = 39 * 250 = 9750
Here Total revenue < Total cost . This shows that firm is incurring a negative profit, that is loss.
In short run, a competitive firm can still choose to produce even in a loss incurring situation, only when total revenue is greater than total avoidable cost.
Total Variable Cost = Average Variable Cost * Number of units produced
=> Total Variable Cost = 9 * 250 = 2250
Total Quasi-fixed Costs = 2,500
Total Cost = Total Fixed Cost + Total avoidable cost
Avoidable costs refers to those costs which is not incurred if there is no production. Variable and quasi fixed costs are avoidable costs.Avoi
Total Avoidable Cost = Total Variable Cost + Total Quasi-fixed Cost
=> Total Avoidable Cost = 2250 + 2500 = 4750
Therefore, total revenue (2500) is less than total avoidable cost (4750).
This is not a profit - maximizing decision.
While the firm is producing, it cannot even recover the entire avoidable cost, so if it continues production, its loss will be total fixed cost and a part of total avoidable cost. That is loss = 9750 - 2500 = 7250.
If the firm shuts down, it will only incur a loss equivalent to total fixed cost. That is loss = 9750 - 4750 = 5000.
Therefore the firm should shut down.
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