Suppose a risk-neutral competitive firm must set output before it knows for sure the market price.Suppose the market price is given by p = p* + e,where p* is the mean price and e is a random term with an expected value of zero.Then in order to maximize expected profits,the firm should produce where:

Question

Quizplus · Accepted Answer

Since e has an expected value of zero, the firm should base its production decision on the mean price, p*, which is the expected market price. Therefore, to maximize expected profits, the firm should produce where the mean price, p*, equals marginal cost (MC). This ensures that the firm is producing at a level where the expected revenue from the last unit produced equals its cost, which is the profit-maximizing condition for a risk-neutral firm in a competitive market.

Suppose a Risk-Neutral Competitive Firm Must Set Output Before It