Question Two:

You are producing in a perfectly competitive market. Your coffee mug company is currently

producing at an output level of 200 mugs per month. Fixed costs are $500 per month. At the

current output level, you know that marginal cost is $10 and equal to average total cost. At an

output level of 150, you have determined that marginal cost would be $6 and equal to average

variable cost. The market price for coffee mugs is $8.

a. If your goal it to maximize profits, should you continue to produce 200 mugs, increase

production above 200 mugs or decrease production below 200 mugs? Illustrate

graphically and explain the rationale behind your decision using the golden rule of profit

maximization. Label this point A.

b. At the profit maximizing output (which you cannot quantify), are you earning a profit or

loss? Should you continue to produce or shut-down? Illustrate all relevant points

graphically and explain using your very best economic vocabulary.

c. Illustrate the short-run equilibrium in the market and label this point A. This point will

correspond to point A at the firm level.

d. In the long-run, trace out the adjustment process that takes you from this short-run

equilibrium position to long-run equilibrium where LRAC=MC=SAC=$10. Be sure to

explain what is happening in your graphs.

e. What is the significance of long-run equilibrium in terms of technical efficiency?

Explain.