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Chapter 18: Problem 679

American Widget Corporation, which has a rising short run Marginal Cost curve is currently operating at a loss. \(\mathrm{AWC}^{\prime} \mathrm{s}\) chief economist says that if P rises a little, output should not be increased because, if it were, Marginal Costs would rise and the company would end up with a bigger loss on a higher volume. Should AWC's president listen to the chief economist? Why or why not?

Short Answer

Expert verified
In summary, AWC's president should consider the chief economist's advice by comparing the change in price (P) with the change in Marginal Cost (MC). If MC increases more than the slight increase in price, it would not be profitable to increase the output. However, if the rise in price brings it equal to or more than the rise in MC, the president may want to consider increasing the output.

Step by step solution

01

Understanding Marginal Cost

Marginal Cost (MC) can be defined as the change in the total cost that arises when the quantity produced changes by one unit. It is the cost of producing one more unit of a good. In the provided scenario, AWC's Marginal Cost curve is rising, implying that the cost of producing additional units is increasing.
02

Understanding Price and Output relationship

Basic economic theory suggests that a firm should increase production up to the point where MC equals the price (P), thereby maximizing total profits or in this case, minimizing losses. This is because when the price one can charge for a good is higher than the MC of producing it, there is an opportunity for a profit.
03

Evaluating the chief economist’s claim

The chief economist of AWC advises against increasing output if price rises slightly. This implies that the economist believes the MC will increase more than the price, leading to a bigger loss. This could only be true if the increase in price is less than the MC of producing the additional units.
04

Making the final decision

AWC's president should consider the chief economist's advice by comparing the change in price with the change in MC. This requires a detailed understanding of the company's cost structure and the market conditions for their product. If the MC increases more than the slight increase in the price, then it would not be profitable to increase the output, hence, AWC's president should consider the economist's advice. But, if the rise in P brings it equal to or more than the rise in MC, AWC’s president may want to consider increasing the output.

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Most popular questions from this chapter

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