Answer to Question #216387 in Microeconomics for Ida

Question

A perfectly competitive firm Cat Paradise sells clothing for cats. A cat-suit sells for $72 each. The fixed costs for production are $100. The total variable costs are $64 for one suit, $84 for two suits, $114 for three suits, $184 for four suits, and $270 for five suits.

 

a)    In a table, calculate TR, MR, TC and MC for each output level (one to five suits).

(10 marks)

b)    What is the profit maximizing quantity?

(5 marks)

 

c)    If the advent of new and better technology in a perfectly competitive market leads to a large reduction in costs of production, how will this affect the market?

(10 marks)

Answer 1

a) Quantity  Price  TR  MR  FC  VC  TC  MC  Profit 

1 $72 $72 0 $100 $64 $164 0 -$92

2 $72 $144 $72 $100 $84 $184 $20 -$40

3 $72 $216 $72 $100 $114 $214 $30 $2

4 $72 $288 $72 $100 $184 $284 $70 $4

5  $72 $360 $72 $100 $270 $370 $86 -$10

b) The profit maximizing quantity is 4 suits.

c) Perfect competitive market ensures that there is allocative and productive efficiency. Since P=MC then the price will be lowered since there is reduction in costs of production. When perfectly competitive firms maximize their profits by producing the quantity where P=MC, they also ensure that the benefits to consumers of what they are buying—as measured by the price they are willing to pay—is equal to the costs to society of producing the marginal units—as measured by the marginal costs the firm must pay. Thus, allocative efficiency holds.