I29. In the reclining chair industry (which is perfectly competitive), two different technologies of production exist. These technologies exhibit the following total cost functions: C1(Q) = 500 + 560Q - 40Q2 + Q3
C2(Q) = 600 + 280Q - 20Q2 + Q3
Due to foreign competition, the market price of reclining chairs has fallen to $170. In the short run, firms using technology 1
A) and firms using technology 2 will remain in business.
B) will remain in business and firms using technology 2 will shut down.
C) will shut down and firms using technology 2 will remain in business.
D) and firms using technology 2 will shut down.
E) More information is needed to make a judgment.

Question

Quizplus · Accepted Answer

In the short run, firms will continue to produce if they can cover their variable costs. For both technologies, the variable cost function is VC(Q) = 560Q - 40Q^2 + Q^3 for technology 1 and VC(Q) = 280Q - 20Q^2 + Q^3 for technology 2. At a price of $170, both technologies will incur losses (since the price is lower than the average variable cost at any quantity). However, firms using technology 2 have a higher average variable cost than firms using technology 1 (for any given quantity) and thus will shut down in the short run. Firms using technology 1 will continue to produce in the short run as long as they are able to cover their variable costs, even if they are making losses.

I29 in the Reclining Chair Industry (Which Is Perfectly Competitive)