Suppose a firm has a variable cost function VC = 20Q with avoidable fixed cost of $50,000.For regulators,the first-best regulated price is ______; the second-best regulated price is ____.
A) $80; $480
B) $480; $105
C) $80; $105
D) $105; $80

Question

Quizplus · Accepted Answer

The first-best price is obtained by setting price equal to marginal cost (P=MC), which, in this case, is given by VC/Q=20. Thus, the first-best regulated price is P=$80.

However, because of the avoidable fixed cost, the firm needs to earn a minimum of $50,000 in revenue to cover its fixed costs. At the first-best price of $80, the firm would produce Q=4000 units, which would generate revenue of $320,000. This revenue is more than enough to cover the fixed cost, so there is no need to set a higher price.

Therefore, the second-best price is obtained by setting price equal to average total cost (P=ATC), which is given by (VC+FC)/Q=(20Q+50,000)/Q=20+50,000/Q. To find the second-best regulated price, we need to find the minimum value of this function, which occurs at Q=2500. Thus, the second-best regulated price is P=$105, which corresponds to a quantity of 2500 units and revenue of $262,500, enough to cover the fixed cost and variable cost.

Suppose a Firm Has a Variable Cost Function VC =