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

A perfectly competitive firm has fixed costs of Rs 500 and, at its profit-maximising output of 50 units where P = MC, has average variable cost of Rs 12 and price of Rs 15. Which statement is correct?

The firm loses Rs 350 but should continue in the short run. Revenue is 750 and variable cost 600, giving a contribution of 150 towards fixed costs of 500. Shutting down would lose the full 500, so continuing is better.

  1. AThe firm makes a profit of Rs 150 and should expand
  2. BThe firm makes a loss of Rs 350 and should shut down
  3. CThe firm makes a loss of Rs 350 and should continue in the short runCorrect
  4. DThe firm makes a loss of Rs 500 and should continue in the short run
  5. The firm breaks even because price exceeds AVC

Explanation

Revenue = 15 x 50 = 750. Variable cost = 12 x 50 = 600. Contribution = 150. Loss = 500 - 150 = 350. Since P exceeds AVC, the firm continues in the short run, as shutting down would lose Rs 500. Option with Rs 500 loss ignores the contribution.

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