Skip to content

IAI Actuarial Core Principles · Business Economics · Relationship between economics and business

A firm in Pune sells 200 units at Rs 50 each. Its total cost is Rs 6,000 at this output. The firm is considering raising output by one unit, which would cost an extra Rs 30 and, because price must fall to sell it, would yield a marginal revenue of Rs 20. Following profit maximisation, what should the firm do?

The firm should reduce output. The marginal unit adds Rs 30 to cost but only Rs 20 to revenue, lowering profit by Rs 10. Profit is maximised where marginal revenue equals marginal cost, so output beyond that point should be cut back.

  1. AIncrease output because price exceeds marginal cost
  2. BIncrease output because average cost is below price
  3. CKeep output unchanged because profit is positive
  4. DReduce output because marginal cost exceeds marginal revenueCorrect
  5. Shut down because marginal revenue is below price

Explanation

Profit rises with output only while MR exceeds MC. Here MR is 20 and MC is 30, so the extra unit reduces profit by Rs 10. The firm should cut output. Comparing price with MC is wrong because the firm faces falling MR.

Did you get it right without looking?

One question tells you little. A timed set on Relationship between economics and business shows your real accuracy, how long you take and where you lose marks.

Practise Relationship between economics and businessFree diagnostic mock

More Relationship between economics and business questions