Skip to content

IAI Actuarial Core Principles · Business Economics · Profit maximisation under perfect competition and monopoly

A firm in a perfectly competitive market is currently producing the output at which its marginal cost equals the market price, and price is above average variable cost but below average total cost. What should the firm do in the short run?

The firm should keep producing where price equals marginal cost. Because price covers average variable cost, revenue contributes to fixed costs, so the short-run loss is smaller than the full fixed-cost loss from shutting down. A price taker cannot raise its price.

  1. AContinue producing at this output, accepting a loss that is smaller than shutting downCorrect
  2. BShut down immediately, because any loss makes production unprofitable
  3. CRaise its price to cover average total cost
  4. DIncrease output until average total cost equals marginal cost
  5. Cut output to where marginal revenue exceeds marginal cost

Explanation

Price exceeds average variable cost, so each unit contributes towards fixed costs. Producing where P = MC loses less than shutting down, in which case the whole fixed cost would be lost. A price taker cannot raise its price, so the other options are wrong.

Did you get it right without looking?

One question tells you little. A timed set on Profit maximisation under perfect competition and monopoly shows your real accuracy, how long you take and where you lose marks.

Practise Profit maximisation under perfect competition and monopolyFree diagnostic mock

More Profit maximisation under perfect competition and monopoly questions