Question

Which one of the following statements is true?1) If the market price falls below the Average Fixed Costs (AFC) of production then the firm will minimize losses by "shutting down" production.2) A firm will earn an economic profit if it sells output at a market price that exceeds the Average Variable Costs (AVC) of production.3) At the current level of production (q) the Marginal Revenue is (MR=) $25 and Marginal Cost is (MC=) $20 the perfectly competitive firm should decrease its' level of production.A. Only Statement (1) is true.B. Only Statements (2) and (3) are true.C. Only Statement (3) is true.D. Only Statements (1) and (3) are true.E. None of the Statements is true.

Answer 1

Answer: E. None of the Statements is true.

Explanation:

Statement 1 is false because the firm should shutdown only after market prices have dropped below Average Variable Costs not Average Fixed costs because the fixed costs have already or will be incurred regardless. The best way to limit losses would be to stop the activity that adds more costs per unit which would be variable costs.

Statement 2 is also false because profit will be made when the firm sells at a price that exceeds Average Total Cost not just Average Variable Cost.

The firm maximises profit at a point where Marginal Revenue equals Marginal Cost. If Marginal Revenue exceed marginal cost as it the case here, it means resources are being underutilised and the perfectly competitive firm needs to produce more to maximise profit not less. Statement 3 is therefore wrong as well.