Hi there. You helped me with a couple of questions regarding Econ. I appreciate the help but my issue is I don't understand how you calculate the minimum average variable cost or the output that maximizes profit. I do understand that the price is more than the AVC so they should keep producing in the short run to cover some of the fixed costs. I appreciate your help. Thank you.

Question

In a perfectly competitive industry, the market price is $25. A firm is currently producing 10,000 units of output, its average total cost is $28, its marginal cost is $20, and its average variable cost is $20. Given these facts, explain whether the following statements are true or false, and why.

a. The firm is currently producing at the minimum average variable cost.

b. The firm should produce more output to maximize profit.
c. Average total cost will be less than $28 at the level of output that maximizes the firm’s

Economics/Math - economyst, Wednesday, November 4, 2009 at 9:11am
take a shot, what do you think.

Hint: true, true, true

Answer 1

OK, lets start with the conventional shapes of the MC and AVC curves. The AVC curve has a U shape to it. At low levels of production, the firm can enjoy some returns to scale. But after a while, the law of diminishing returns kicks in, and costs begin to rise. This latter effect means a rising MC curve. REGARDLESS, if MC is less than AVC, then AVC must be declining, if MC is above the AVC curve, the AVC curve must be rising. So, the MC curve always touches the AVC curve at its minimum point. (Unless you have some wave-shaped curve, which we never do or assume).
Think about it. If the current average cost of producing widgets is 15 and the MC of producing one more widget is $10, what must happen to the average when the extra unit is produced? Further, we could apply this same reasoning for the average total cost curve.

So, you are given MC=$20 and AVC=$20. It must be also true that the AVC is at its minimum point. So, a) is true

b) In the perfectly competitive firm, price is also the marginal revenue (MR). Always always always maximize profits where MC=MR. Since, as given, P=MR=$25 and MC=20, the firm should produce more. So b) is true.

c) Note AVC = (variable costs)/Q and ATC = (fixed + variable costs)/Q (where Q is output)
Go back to a) if the firm increase production from where MC goes from 20 to 25, What must happen to ATC if it started at $28. Since MC < ATC, with each additional unit, ATC must fall. So c) is true

Answer 2

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