A monopolistically competitive firm is currently charging a price of $20 and producing 3,000 units/month. It faces monthly fixed costs of $1,000 and has an average variable cost of $22/unit. We would expect:
A)The firm to earn an economic profit in the long run
B)The firm to shut down in the short run
C)The firm to raise its price to cover its variable costs
D)The firm to adjust its production to minimum efficient scale

Question

​A monopolistically competitive firm is currently charging a price of $20 and producing 3,000 units/month. It faces monthly fixed costs of $1,000 and has an average variable cost of $22/unit. We would expect:
A)​The firm to earn an economic profit in the long run
B)​The firm to shut down in the short run
C)​The firm to raise its price to cover its variable costs
D)​The firm to adjust its production to minimum efficient scale

Quizplus · Accepted Answer

The firm is currently incurring losses since its price of $20 is lower than its average total cost of $22 ($1,000 + $22*3,000 = $67,000 total cost, which gives an average total cost of $22.33). In the short run, the firm should shut down since it cannot even cover its variable costs with its current price. In the long run, other firms may exit the market due to the losses, which could increase demand for the existing firms and allow them to earn economic profits (if demand increases enough to allow them to charge a higher price). However, this is not guaranteed and will depend on the specific market conditions. The firm cannot raise its price to cover its variable costs since the demand curve it faces is downward sloping, meaning that consumers will buy less at higher prices. The firm is also not at minimum efficient scale since it is producing less than the optimal output level for cost minimization.

​A Monopolistically Competitive Firm Is Currently Charging a Price of $20

A Monopolistically Competitive Firm Is Currently Charging a Price of $20