Question

Question. Suppose you are a consultant for a perfectly competitive firm seeking an assessment of its policies in the short run. What would you recommend in terms of quantity changes (raise, cut, shut down, or stay put) and price changes (raise, cut, or stay put) in each of the following situations (a through e):

a. [10 points] P = $1210; MC = $1205; AVC = $1206.

b. [10 points] P = $1210, MC = $1210, AVC= $1206.

c. [10 points] P = $2210, MC = $2210, AVC = $2211.

d. [10 points] P = $1210; MC = $1205; AVC = $1212.

e. [10 points] P = $ 3210, MC = $3212, AVC = $3206.

Answer 1

In a perfectly competitive market, a firm's short-run decisions on quantity should align with where MR equals MC, and it should continue producing if P is greater than AVC, and shut down if P is less than AVC. The firm typically has no power to change the price in such a market. Recommendations vary across scenarios: continue production but no price change for (a), (b), and (e), and shut down for (c) and (d).

Step-by-step explanation:

When consulting for a perfectly competitive firm regarding short-run production decisions, your recommendations on quantity and price changes should be based on the firm's marginal cost (MC), average variable cost (AVC), and the market price (P). Here are the recommendations for each scenario:

• a. P = $1210; MC = $1205; AVC = $1206. Recommendation: Continue production but do not change price. The price is above MC and AVC, so the firm should continue to produce, but since P is not substantially higher than AVC, no price change is advised.
• b. P = $1210, MC = $1210, AVC= $1206. Recommendation: Continue production and stay put with the price. Here, the firm is breaking even at the margin and the price is above AVC.
• c. P = $2210, MC = $2210, AVC = $2211.Recommendation: Shut down. Since the price is below AVC, the firm should shut down to minimize losses.
• d. P = $1210; MC = $1205; AVC = $1212. Recommendation: Shut down. The price is below AVC, thus the firm will minimize losses by stopping production.
• e. P = $ 3210, MC = $3212, AVC = $3206. Recommendation: Continue production but do not change the price. Price is above AVC, indicating continuation of production is favorable, but with MC slightly above P, the firm should assess other factors before considering a price change.

In a perfectly competitive market, firms are price takers, and the market sets the price. Therefore, firms do not have the power to raise or lower the price, but they can decide on the quantity to produce. The principal goal is to produce where marginal revenue (MR) is equal to marginal cost (MC), as long as P is greater than AVC, to maximize profits or minimize losses in the short run.