Author Question: Why does the model of perfect competition imply that firms will produce the products that households ... (Read 227 times)

michelleunicorn · **on:** Jun 29, 2018

Why does the model of perfect competition imply that firms will produce the products that households want the most?

What will be an ideal response?

Question 2

Bubba's Burgers sells hamburgers in a perfectly competitive market at a price of 1.50 each. At the profit-maximizing (cost-minimizing) level of output, average total cost is 1.90 per hamburger and average variable cost is 1.75 per hamburger.

Should the firm continue to operate in the short run? Explain.

Mollythedog · **Reply #1 on:** Jun 29, 2018

Answer to Question 1

In perfect competition, firms maximize profit by producing where price is equal to marginal cost. The price of a good reflects the value that buyers place on the good. The marginal cost of a good represents the opportunity cost of the resources used to produce the good. Producing a good at a level where price is greater than marginal cost means that society could benefit from producing more of the good. On the other hand, producing the good at a level where price is less than marginal cost means that resources are being used to produce something that households value less than its opportunity cost. In this case, society could benefit by producing less of the good. Thus, if firms always produce where price is equal to marginal cost, the efficient mix of output will be produced.

Answer to Question 2

No. The price of the firm's product (1.50) is less than its average variable cost (1.75). This implies that the firm's revenues will not be sufficient to cover all of the firm's variable costs. Thus, it will earn a smaller loss if it shuts down and earns a loss equal to its fixed costs.