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. P = $1210; MC = $1205; AVC = $1206.

b. P = $1210, MC = $1210, AVC= $1206.

c. P = $2210, MC = $2210, AVC = $2211.

d. P = $1210; MC = $1205; AVC = $1212.

e. P = $ 3210, MC = $3212, AVC = $3206.

Answer 1

In situation a, the firm should continue to produce. In b and c, the firm should also continue to produce. In d, the firm should shut down. In e, the firm should shut down.

Step-by-step explanation:

a. P = $1210; MC = $1205; AVC = $1206:

In this situation, the market price P is greater than the average variable cost AVC. Therefore, the firm should continue to produce in the short run. There is an opportunity to make a profit.

b. P = $1210, MC = $1210, AVC= $1206:

Here, the market price P is equal to both the marginal cost MC and the average variable cost AVC. The firm should continue to produce in the short run because it can cover both its variable and fixed costs.

c. P = $2210, MC = $2210, AVC = $2211:

In this case, the market price P is equal to both the marginal cost MC and the average variable cost AVC. However, the market price is higher than the average total cost ATC. Therefore, the firm should continue to produce, as it can cover both its variable and fixed costs.

d. P = $1210; MC = $1205; AVC = $1212:

Here, the market price P is greater than the marginal cost MC but lower than the average variable cost AVC. In this situation, the firm should shut down in the short run because it cannot cover its variable costs.

e. P = $3210, MC = $3212, AVC = $3206:

In this scenario, the market price P is lower than both the marginal cost MC and the average variable cost AVC. The firm should shut down in the short run to minimize losses as it cannot cover its variable costs.