CFA Level I · CFA Level I Exam · The Firm and Market Structures
A perfectly competitive firm sells its output at a market price of $12 per unit. At its current output, marginal cost is $15 and rising, and price exceeds average variable cost. To maximize profit (or minimize loss), the firm should most likely:
The firm should reduce output. Marginal revenue equals the $12 price, but marginal cost is $15, so the last unit produced lowers profit. Cutting output moves the firm down its rising marginal cost curve until marginal cost equals $12. Price exceeds average variable cost, so shutting down is wrong.
- Areduce outputCorrect
- Bincrease output
- Cshut down immediately
Explanation
Profit maximization requires MR = MC. For a price taker MR equals price, $12. Since MC of $15 exceeds MR of $12, the last unit adds more to cost than to revenue, so output should be cut until MC falls to $12. Shutdown is unwarranted because price exceeds average variable cost.
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