Elasticity and Market Power
A firm in a perfectly competitive market has the following cost functions:
| Total Output | Total Variable Cost (USD) | Total Fixed Cost (USD) |
|--------------|--------------------------|-----------------------|
| 0 | 0 | 50 |
| 10 | 30 | 50 |
| 20 | 45 | 50 |
| 30 | 55 | 50 |
| 40 | 75 | 50 |
| 50 | 100 | 50 |
If the price in the market is USD 2 per unit, which output level is closest to the point at which the firm will _most likely_ produce in the short run?
Incorrect.
It is true that the firm does not earn profits at any output level. However, producing nothing still involves a loss of USD 50, the fixed cost. The firm can lower the loss by producing at a positive output level.
Incorrect.
At this output, the revenue is maximized, but the loss is not minimized.
Good.
The profit-maximizing, or loss-minimizing, rule is to set marginal revenue equal to marginal cost. In this market structure, the price is the marginal revenue.
Here, you can see that from 20 units, making another 10 costs just 1 per unit. at a sales price of 2, MR>MC, so move to 30.
From 30, the next 10 units cost 2 each, so you are at MR=MC. It doesn't matter if you move forward to 40 or not, so 30 is the best choice here.
If you go all the way to 50, you have spent an extra 2.5 per unit to then sell them at 2 per unit, reducing profits.
0
30
50
