Question

Suppose a perfectly competitive firm produces and sells 15 units of output per-period (e.g., daily) for the market price of 8. If its average fixed costs are 2 and its average variable costs are 3, then the firm:

1) is maximizing total profit by producing and selling 15 units of output
2) earns a per-period total profit of 45
3) earns a per-period total profit of 120
4) should close down in the short run and suffer a loss equal to 30

Answer 1

The perfectly competitive firm sells 15 units at $8 each, totaling $120 in revenue. With average costs of $5 per unit, the total costs amount to $75, resulting in a profit of $45 for the period, so the firm should continue production as it is making a profit.

Step-by-step explanation:

To determine whether the perfectly competitive firm is making profits, we need to compare the market price to the firm's average total cost (ATC), which is the sum of average fixed costs (AFC) and average variable costs (AVC). The ATC here is 2 (AFC) + 3 (AVC) = 5. Since the firm sells 15 units at a market price of 8, the total revenue (TR) is 15 units × $8/unit = $120. The total cost (TC) is 15 units × $5/unit (ATC) = $75. Subtracting TC from TR, the total profit is $120 - $75 = $45. So, the firm earns a per-period total profit of $45.

Given that the firm's market price is above its ATC, the firm is indeed making profits and should continue production in the short run. The best options from those provided would be that the firm earns a per-period total profit of $45 and maximizes total profit by producing and selling 15 units if this quantity is where marginal revenue equals marginal cost, which we assume is true given that the question provides no information to the contrary. Therefore, it is incorrect that the firm should shut down in the short run and suffer a loss equal to $30, as the firm is covering its variable costs and contributing to fixed costs.