Question

A firm sells a product in a purely competitive market. The marginal cost of the product at the current output is $4.00 and the market price is $4.50. What should the firm do? Multiple Choice shut down if the minimum possible average variable cost is below $4.50 increase output if the minimum possible average variable cost is below $4.50 decrease output if the minimum possible average variable cost is below $4.50 decrease output if the minimum possible average variable cost is above $4.50

Answer 1

increase output if the minimum possible average variable cost is below $4.50.

Step-by-step explanation:

Contributing margin of a product is the selling price less the variable cost it takes to produce the product.

The contribution margin is the portion of revenue that is not consumed by variable cost.

Generally contributing margin is low in labour intensive production, while it is high in capital intensive production.

In this scenario if the minimum possible average variable cost is below $4.50 then the contributing margin will be positive. The business can keep increasing output tiil contributing margin is zero, at this point the business is no longer making profit.