Author Question: Frank Banks manufactures and sells piggy banks in a perfectly competitive market. The firm recently ... (Read 29 times)

CBme · **on:** Jun 29, 2018

Frank Banks manufactures and sells piggy banks in a perfectly competitive market. The firm recently purchased new equipment with an expected rate of return of 7 percent.

If the market rate of interest is 8 percent, was the firm's decision to purchase the equipment a wise one? Explain.

Question 2

When XYZ Corporation produces 35 units of output its average variable cost is 5 . The marginal cost of the 36th unit of output is 7 . If the firm chooses to produce the 36th unit of output, what will happen to average variable cost? Explain.

What will be an ideal response?

isabelt_18 · **Reply #1 on:** Jun 29, 2018

Answer to Question 1

No. A perfectly competitive firm should keep investing in capital up to the point where the expected rate of return is equal to the interest rate. In this case, the interest rate is higher. This implies that the opportunity cost of the funds used to purchase the equipment is greater than the expected revenues from the equipment. Thus, it was a bad decision.

Answer to Question 2

If the firm decides to produce the 36th unit of output, its average variable cost will rise because the marginal cost is greater than the average variable cost.