Question

If a specific subsidy​ (negative tax) of s is given to only one competitive​ firm, how should that firm change its output level to maximize its profit​, and how does its maximum profit​ change? Let the market price be​ p, the marginal cost of production​ (prior to the​ subsidy) for the firm be​ MC, and the subsidy be s. To maximize profit with the​ subsidy, the firm should A. decrease its production until pequalsMC. B. increase its production until pequalsMCminuss. C. increase its production until pequalss. D. increase its production until pequalsMCpluss. E. not change its level of production.

Answer 1

The correct answer is option D.

Explanation:

The market price is P.

The marginal cost is given at MC.

The subsidy is equal to s.

When the subsidy is provided to only a single firm, that firms marginal cost will decline. The firm can take advantage of decreased marginal cost by increasing the output level. The firm will produce the output where the price and marginal revenue is equal to marginal cost plus subsidy. At this point, the firm will be having maximum profit.

So, the firm will increase production until

P=MC+S