A perfectly competitive firm that makes car batteries has total fixed costs of $10,000 per month.
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A perfectly competitive firm that makes car batteries has total fixed costs of $10,000 per month. The market price at which it can sell its output is $100 per battery. The firm’s minimum AVC is $105 per battery. The firm is currently producing 500 batteries a month (the output level at which MR = MC). This firm is making a _____________ and should _______________ production. LO10.5 a. profit; increase c. loss; increase b. profit; shut down d. loss; shut down |
Here is the full solution including the answer and explanation.
Explanation
d is correct
The price is less than the minimum of the AVC. This means that the firm is unable to cover its fixed cost as well as the variable cost. Consequently, the firm needs to shut down production to minimize its loss, as the firm is currently earning negative profit. If the firm shuts down the business, it would have to bear a loss of only $10,000, but if it continues to produce, it would have to bear more loss.
a is incorrect
The firm does not make a profit because the price is lower than the average variable cost (AVC). Consequently, the firm does not need to increase production, as if it does so, it would incur more loss, which would be higher than the fixed cost. Under this situation, the firm should shut down its production process.
b is incorrect
The firm would not earn any profit because the price is not greater than the AVC. However, the firm needs to shut down the business if it does not want to incur any further loss.
c is incorrect
As the price is lower than the AVC, the firm would incur loss. The firm needs to stop producing any further output rather than increasing the output. This is because it would cost the firm more than the fixed cost and a part of the variable cost.
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