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all 3 are related

Questions 7, 8 and 9 are based on the following


  1. Suppose a firm has a production technology which results in the commonly seen outcome of "U-shaped" Average Variable Cost (AVC), Average Total Cost (ATC) and Marginal Cost (MC). Further, suppose this firm sells its product in a market where the price of the good is externally set at P0. That is, the price is given to the firm and the firm cannot impact that price. Finally, for the entirety of this set of questions (7-9), assume we are in the Short Run for this firm.
  2. In graphing responses to Questions 7 through 9, put $ on the vertical axis and lower-case q (firm output) on the horizontal axis.
  3. Consider a scenario when the firm operates at a profit-maximizing level (produces a proft-maximizing quantity) yet (a) has negative profits at this outcome and (b) it does not choose to shut down.
  • Graphically depict all relevant cost curves (ATC, AVC, AFC, MC) and label them as well as the price P0 and the equilibrium q0
  • Graphically indicate the area associated with negative profits made by the firm. Explain why this area represents negative profits.
  • Explain the decision to keep producing in the face of negative profits.

 graph and a narrative response where indicated as an answer to this question.

Question 8 

Now suppose that the firm is hit with a new Licensing Fee that raises its fixed cost of operation significantly, but does not impact the variable cost or marginal cost.

  • Which of the firm's costs will be impacted by the new licensing fee? Why?
  • Will the new licensing fee change the firm's profit-maximizing (equilibrium) quantity? Why or why not?
  • What should the firm's response be since it is still in the short run? What will determine whether a firm will continue operating or shut down? Explain.

Answer this question with a narrative response 


This firm has no control over the market price of P0. However, for this question assume the market price increases to P1, which is greater than the original price P0.

  • Using the same graph, and the same cost curves you displayed in Question 7, draw the new price line in such a way that this new price will result in positive economic profits for the firm.
  • Clearly label the firm's new profit-maximizing (equilibrium) quantity q1.
  • Graphically indicate the area associated with positive profits made by the firm on the graph. Explain why this area represents positive profits.

graph and a narrative response where indicated as an answer to this question.

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