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?

Question

Quizplus · Accepted Answer

In a purely competitive market, the firm should produce at the level where marginal cost equals market price. Here, the marginal cost is $4.00 and the market price is $4.50, which indicates that the firm is earning a positive economic profit. To maximize its profit, the firm should increase output until the marginal cost equals the price, which will be at the minimum point of the average variable cost curve. Hence, the firm should increase output if the minimum possible average variable cost is $3.75. If the minimum possible average variable cost is $3.00, the firm should still continue to produce in the short run, as it can still cover its variable costs and a portion of fixed costs. Shutting down would incur a loss equal to the fixed cost. Decreasing output will cause a lower level of profit as the marginal cost is still lower than the market price.

A Firm Sells a Product in a Purely Competitive Market