Question

You are one of 5 identical firms (i.e., you all have the same costs) that sell widgets. Each day you have a fixed cost of $9 to operate. The marginal cost of your first through fifth widgets are $1, $2, $3, $7, and $8, respectively. You have a capacity constraint of 5, and you can only produce a whole number of widgets.
a. What is the average variable cost (AVC) for a firm that produces 2 widgets?

b. What is the market-level quantity supplied given a price of $2.50?

c. Suppose the market-level demand is fixed at 18. In other words, there is perfectly inelastic demand. What is the equilibrium price in the short run?

d. Given perfect competition, what will be the price in the long run?

Answer 1

Answer:

a. $1.5; b. 10 units; c. $7; d. $6

Explanation:

There are 5 identical firms in a market.

These firms sell widgets.

The fixed cost of each firm is $9.

The marginal cost of your first through fifth widgets are $1, $2, $3, $7, and $8, respectively.

a. The total variable cost for producing two widgets

= $1 + $2

= $3

The average variable cost

= $\frac{TVC}{Q}$

= $\frac{3}{2}$

= $1.5

b. The firms will supply the level of output where the price is able to cover the marginal cost of production.

At the price level $2.5, the marginal cost of producing 2 units i.e $2 is being covered. So the firms will supply 2 units each. The market supply will be 10 units.

c. The equilibrium price will be such that it is able to cover the marginal cost of production and the average variable cost.

The average variable cost

= $\frac{TVC}{Q}$

= $\frac{13}{4}$

= $3.25

That price is $7, so it will be the equilibrium price.

d. In the long run, the equilibrium price will be determined at the point where price equals ATC.

The total variable cost for producing two widgets

= $1 + $2 + $3 + $7 + $8

= $21

The total cost

= TFC + TVC

= $21 + $9

= $30

The average total cost

= $\frac{TC}{Q}$

= $\frac{30}{5}$

= $6

So, the long run price will be $6.