(Microeconomics) - Assignment Example

Question The farmer is not maximizing his profit because marginal revenue (Price = 22 cents) is not equal to marginal cost (MC =30 cents) of producing sugar at the given level. Since marginal cost increases by increasing the quantity produced, the farmer should producer lesser than 100,000 pounds and decrease the sugar production up to the level where marginal cost cuts back to equal the price i.e. 22 cents. In that case, the farmer would be maximizing the profit. Question 2 Increase in price of butter may be due to increase in its quantity produced.

More specifically, following an increase in demand, the producer increases the production of butter. But since increase in quantity produced raises marginal cost, producer of butter would raise its price to keep up with the increased marginal cost (to maximize profit). Thus, price begins to rise. Now, if the demand for butter drops, producer would cut their production and thus the marginal cost again decreases and they can lessen the price too because now the profit maximizing condition (MR = MC) can be satisfied at the lower price.

Question 3 In a perfectly competitive industry, economic profits disappear in the long run because entry and exit of a firm is free of barriers which allows the number of firms to remain up to the level of zero economic profits as opposed to an imperfectly completive industry where entry barriers prevent other firms from entering the industry and thus from exhausting the profits. For a perfectly competitive industry, economic profit attracts the new suppliers in the market as they can freely enter.

New entries is continued until ATC = price. This is because if ATC > price (positive profit), more firms will enter and thus absorb the profit and if ATC < price, firms will shut down in long run (as exit is also free in perfect competition) to avoid the economic loss and thus price and ATC again becomes equal – zero economic profit. Question 4 Suppose the firm is a profit-maximizing firm. Specifically, its current number of packages delivered can be assumed up to the level where its marginal cost equals price per package ($13).

Now if a worker comes late, the number of packages delivered decreases by one package and so will be the marginal cost. But as the profit maximizing principle allows marginal cost to be increased up to the level where it equals price, decrease in marginal cost in this case owing to the decrease in output would lessen the profit and firm wouldn’t be at its profit maximizing profit. That is, since MC becomes now lesser than price (MC < P), firm should increase number of packages delivered and thus to allow MC to be increased to equal to the price.

And if output and thus MC doesn’t exceed to become equal to price, profit would be less than the maximum level, since in that case quantity (part of profit amount) also decreases. Question 5 Although variable cost exceeds the total revenue at the current production level of 100 units per day, the decision to shut down should precisely depend on the average revenue and average variable cost at the profit-maximizing level (“Perfect Competition, Shutdown.” AmosWEB.com). In the given case, the firm is currently not operating at profit-maximizing level; price ($22) is much less than MC ($45).

Price or average revenue is also less than average variable cost ($25). Since the price is not enough to cover even AVC, the firm is producing too much and therefore it should cut its production so that its marginal cost decreases and so does its AVC to become lesser than or at least equal to the price. If the firm is not able to cut its production up to the level where AVC equals price (zero economic profit), it should shut down until either the price increases to cover AVC or it can control down its AVC.

Yet, this evaluation is from economic point of view. Yet, from an accountant’s point of view, if the firm’s total revenue doesn’t cover its total variable cost, it should shut down because in that case there would be no accounting profit, even if firm is at its profit maximizing level. Works Cited “Perfect Competition, Shutdown.” AmosWEB.com. AmosWEB Encyclonomic WEB*Pedia, n.d. Web. 8 March 2011