Pictured above are the Marginal Cost, Average Variable Cost and Average Total Co
ID: 1219534 • Letter: P
Question
Pictured above are the Marginal Cost, Average Variable Cost and Average Total Cost schedules of a contract sewing factory which produces women's blouses for major clothing retailers. Prices are contract prices per dozen blouses. Quantities are thousands of dozens per month. Arrows show some Price - Quantity combinations on the cost curves. Assume that there are 500 firms in the market and all are using the same technology as this firm. a) What is the minimum efficient scale of production for this firm? Explain in a sentence or two. b) At what level of output does the firm start to experience diminishing marginal productivity of its variable inputs. (Explain in a sentence or two) c) If the current market price is $95/dozen, how much will this firm produce per month? (explain in a few sentences) d) Is this the long run equilibrium price in this market? Explain your answer in detail and if there is a different equilibrium price identify that price. e) What would be the effect of a sharp rise in the price of cotton assuming the higher cotton price persisted into the long run. Which curves would be affected? How would the long run equilibrium price change? f) In (e) would the Minimum efficient scale of production change? If so, how?Explanation / Answer
(a) Minimum efficient scale of output = 185,000 units.
Production is at the minimum efficient scale when average total cost (ATC) is at its lowest which occurs at Q = 185,000.
(b) Firm starts to experience diminishing marginal productivity of variable inputs from 160,000 units, because after this level, average variable cost (AVC) curve starts rising.
(c) At price of $95, firm will produce 200,000 units because for a perfectly competitive firm (price taker), profit is maximized when price equals MC, i.e. MC = $95, at which level Q = 200,000.
(d) This is not the long run equilibrium because, in perfectly competitive industry, long run equilibrium occurs when price equals ATC equals MC, but here ATC is not equal to MC.
Note: First 4 sub-parts are answered.