Question:
In the short run when a perfectly competitive firm operates at its profit maximising level of output of 1000 units, market price is Rs. 120 per unit, variable cost per unit is Rs. 100 per unit and fixed cost is Rs. 40 per unit. Other things being equal, the short run behaviour of the firm should be to
(1) reduce output in order to reduce costs.
(2) increase the price over Rs. 140 per unit.
(3) continue to produce as it operates in the short run.
(4) increase output level in order to reduce average fixed cost.
(5) shut down immediately as average total cost is above the market price.
Correct Answer:
(3)
Answer Explanation:
Average Total Cost (ATC) = AVC (100) + AFC (40) = 140. Since Price (120) < ATC (140), the firm makes a loss. However, because Price (120) > AVC (100), the firm covers all its variable costs and contributes Rs. 20 per unit towards its fixed costs. It minimizes losses by continuing to produce in the short run.
Topic: Market Structures Year: 2021
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