Sub part (a):
Calculation of economic profit.
Sub part (a):
Explanation of Solution
Table -1 shows the data for the purely competitive producer
Table -1
Quantity | Average fixed cost | Marginal cost | ||
1 | 60 | 45 | 105 | |
2 | 30 | 42.5 | 72.5 | 45 |
3 | 20 | 40 | 60 | 35 |
4 | 15 | 37.5 | 52 | 30 |
5 | 12 | 37 | 49 | 35 |
6 | 10 | 37.50 | 47.5 | 40 |
7 | 8.57 | 38.57 | 47.14 | 45 |
8 | 7.5 | 40.63 | 48.13 | 55 |
9 | 6.67 | 43.33 | 50 | 65 |
10 | 6 | 46.5 | 52.5 | 75 |
A profit maximizing firm produces output at the point where the marginal revenue equals to or greater than the marginal cost. Marginal revenue is equal to the price. At the price of $56, the marginal revenue is just greater than the marginal cost at the output level of 8 units. Thus, the profit maximizing output level is 8 units. At this point, the average variable cost is less than the price. Thus, the firm is operating in the short run.
Economic profit can be calculated as follows:
The economic profit is $62.96.
Concept introduction:
Accounting profit: Accounting profit refers to the total revenue minus total explicit cost
Economic profit: Economic profit refers to the total revenue minus implicit and explicit cost.
Sub part (b):
Calculation of economic profit.
Sub part (b):
Explanation of Solution
At the price of $41, the marginal revenue is greater than the marginal cost at the output level of 6 units. Thus, the profit maximizing output level is 6 units. At this point, the average variable cost is less than the price. Thus, the firm is operating in the short run.
Economic profit can be calculated as follows:
The economic profit is -$39.
Concept introduction:
Accounting profit: Accounting profit refers to the total revenue minus total explicit cost
Economic profit: Economic profit refers to the total revenue minus implicit and explicit cost.
Sub part (c):
Shutdown decision.
Sub part (c):
Explanation of Solution
At the price of $32, the marginal revenue is greater than the marginal cost at the output level of 4 units. Thus, the profit maximizing output level is 8 units. At this point, the average variable cost ($37.5) is greater than the price. Thus, the firm will shutdown at this price. The firm’s economic loss is at the fixed cost $60.
Concept introduction:
Pure competition:
Profit maximizing output: Profit maximizing output occur at the point where the marginal revenue and marginal cost intersect each other.
Shutdown point: In the short run, a firm shuts down at the point where the price of goods is less than the average variable cost.
Sub part (d):
Average variable cost and profit maximization.
Sub part (d):
Explanation of Solution
Output at the price $26 is zero since the marginal revenue is less than the marginal cost at all the output levels.
Profit can be calculated by using the following formula.
Substitute the respective values in equation (1) to calculate the profit at the price $26.
Thus, profit is -$60.
Quantity supply can be calculated by using the following formula.
Substitute the respective values in equation (2) to calculate the total supply for 1,500 firms.
Total supply at price $26 is 0 units.
Table -2 shows the output level obtained by using profit maximization condition
Table -2
Price | Quantity supplied for a single firm | Profit or loss | Quantity supplied for 1,500 firms |
26 | 0 | -60 | 0 |
32 | 0 | -60 | 0 |
38 | 5 | -55 | 7,500 |
41 | 6 | -39 | 9,000 |
46 | 7 | -7.98 | 10,500 |
56 | 8 | 62.96 | 12,000 |
66 | 9 | 144 | 13,500 |
Concept introduction:
Pure competition: Perfect competition refers to the market structure featuring more number of sellers and buyers in the market where the firm can sell the homogenous products.
Profit maximizing output: Profit maximizing output occur at the point where the marginal revenue and marginal cost intersect each other.
Shutdown point: In the short run, a firm shuts down at the point where the price of goods is less than the average variable cost.
Sub part (e):
Supply schedule.
Sub part (e):
Explanation of Solution
Supply schedule refers to the total supply of the industry at different price levels. This can be derived from the Table -2, where column 1is price and column 4 is supply. This is given in the Table -3.
Table -3
Price | Quantity supply |
26 | 0 |
32 | 0 |
38 | 7,500 |
41 | 9,000 |
46 | 10,500 |
56 | 12,000 |
66 | 13,500 |
Concept introduction:
Supply schedule: Supply schedule refers to the table that shows the availability of supply at different price level.
Sub part (f):
Scenario for contraction in the production.
Sub part (f):
Explanation of Solution
Table -4 shows the demand and supply schedule.
Table -4
Price | Quantity demanded | Quantity supply |
26 | 17,000 | 0 |
32 | 15,000 | 0 |
38 | 13,500 | 7,500 |
41 | 12,000 | 9,000 |
46 | 10,500 | 10,500 |
56 | 9,500 | 12,000 |
66 | 8,000 | 13,500 |
In Table -4, the market is in equilibrium at the point where the demand and supply is equal (10,500 units) at the price level $46. Thus,
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