The VCR manufacturing business is perfectly competitive.Suppose that currently, firms that manufacture VCRs utilize either technology 1 or technology 2,whose cost functions are TC1(Q)  340  20Q  Q2
TC2(Q)  405  30Q  Q2
In the long run, assuming no new manufacturing technologies,what will happen in this industry?

A) Firms utilizing technology 1 and firms utilizing technology 2 will stay in business.
B) Firms utilizing technology 1 will stay in business, but firms utilizing technology 2 will shut down.
C) Firms utilizing technology 1 will shut down, but firms utilizing technology 2 will stay in business.
D) Firms utilizing technology 1 and firms utilizing technology 2 will shut down.
E) None of the above.

Question

Wendy Salazar · Accepted Answer

Final Answer : B, Explanation :  In a perfectly competitive market, firms will continue to produce as long as their price is greater than or equal to their average variable cost (AVC). The AVC for both technologies is AVC1(Q) = 340 - 20Q + Q^2/  and AVC2(Q) = 405 - 30Q + Q^2/ . For both technologies, the AVC is downward-sloping and reaches its minimum at Q= . This means that the firms will produce at this quantity as long as the price is greater than or equal to the AVC at that quantity.For technology 1, the price will need to be greater than or equal to the AVC at Q= , which is AVC1( ) = 100. Since the fixed cost is 340, the price will need to be greater than or equal to 440 for firms to continue producing using technology 1.For technology 2, the price will need to be greater than or equal to the AVC at Q= , which is AVC2( ) = 270. Since the fixed cost is 405, the price will need to be greater than or equal to 675 for firms to continue producing using technology 2.Since the price in a perfectly competitive market is determined by industry supply and demand, and firms have no control over the price, it is possible that the price may be greater than or equal to 440 but less than 675. In this case, firms using technology 1 will continue to produce while firms using technology 2 will shut down. Therefore, the correct answer is B.

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