Fig. 1 shows average cost (AC), average revenue (AR) and marginal cost (MC) for a firm producing refillable pens. The firm can sell every pen for the same p...
Question 1 Report
Fig. 1 shows average cost (AC), average revenue (AR) and marginal cost (MC) for a firm producing refillable pens. The firm can sell every pen for the same price.
Which curve represents the price received for each pen? [1]
Explain why AR is horizontal in this diagram. [2]
Show the condition for maximum profit using the curves shown. [2]
Use Fig. 1 to explain why a fall in the firm's average cost can increase profit, if AR remains unchanged. [3]
Analyse one possible benefit and one possible drawback of the firm using lower-cost materials to reduce AC. [6]
Answer Details
(a) The price received for each pen is shown by AR, average revenue. [1]
(b) AR is horizontal because the firm receives the same price for every pen sold. [1] Therefore average revenue does not change as output changes. [1]
(c) Maximum profit occurs where \(MC=AR\). [1] At this output, the additional cost of producing one more pen equals the additional revenue received from that pen. [1]
(d) A fall in AC means that the cost per pen falls. [1] If AR is unchanged, the gap between AR and AC becomes larger. [1] This larger gap represents higher profit per pen, and therefore can mean higher total profit at the relevant output. [1]
(e) A benefit of lower-cost materials is that material costs fall, reducing AC; this may increase profit or allow the firm to lower its selling price. [2] A drawback is that cheaper materials may reduce the pens’ quality or reliability. [2] Consumers may then buy fewer pens, or the firm’s reputation may fall, reducing revenue and potentially offsetting the cost saving. [2]
Do not assume lower AC always raises profit. Profit also depends on revenue, so the effect on product quality and demand matters.
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