The market equilibrium price is 9 We know that given this pr

The market equilibrium price is $9. We know that given this price, the firm’s profit-maximizing output is 1 unit. We also know that if the firm produces one unit of output it incurs total cost of $14.33. Also, the firm’s fixed cost is $5. A.) What profit does this firm earn at the profit-maximizing output? Show your work. B.) What variable cost does the firm incur if it produces one unit of output. Explain how you reached your answer. C.) What should this firm do in the short-run. Explain. (Keeping in mind the firm’s short-run shut-down condition.) D.) What should this firm do in the long-run. Explain.

Solution

A) Profit of the Firm = Total revenue (=Price*Quantity) - Total Cost.

Profit = 9*1 - 14.33 = - 5.33. That is the firm incurs losses in the short run.

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B) Total Cost(TC) = Fixed Cost(FC) + Variable Cost(VC)

TC = 14.33 and FC = 5

VC = TC - FC = 14.33 - 5 = 9.33.

Since the variable cost is cost incurred by the firm depending on the amount of output it produces, so here the variable cost will be equal to (TC - FC) as the firm produces only one unit of output.

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C) The shut down point for a firm is the point where price is less than or equal to the average variable cost(AVC).

Here, P = 9.

And AVC = VC / Q

VC = 9.33.

So, AVC = 9.33.

Here we can see that P = 9 is less than AVC = 9.33. So, the firm should not operate and stop production, since by producing it will increase its loss than by not producing.

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D) Since the firm should not produce in the short run as will earn losses if it chooses to produce. But the long run production scenario of the firm will depend on the scenario of the market, the number of firms in the market after entry and exit. Since in the long run, every firm earns zero economic profits, so the firm in question should produce in the long run.