AP Micro · Unit 3 · Production, Cost, and the Perfect Competition Model

Kestrel Pallets is a typical profit-maximizing firm in the constant-cost, perfectly competitive market for wooden pallets, where the price is $40 per pallet. Its Medium plant's short-run average total cost has a minimum of $30 at 1,000 pallets, and its minimum average variable cost is $18. The table shows long-run average total cost ($LRATC$) for three plant sizes.

(a) Draw a correctly labeled graph of Kestrel Pallets' cost and revenue curves, and show each of the following:

• (i) an upward-sloping $MC$ curve crossing the minimum point of a U-shaped $ATC$ curve
• (ii) a U-shaped $AVC$ curve lying below $ATC$, with $MC$ also crossing its minimum point
• (iii) a horizontal line at the market price of $40, labeled $P = MR = d$
• (iv) the profit-maximizing quantity, labeled $Q_1$, where $MC = MR$
• (v) a shaded area or clearly identified rectangle representing Kestrel Pallets' economic profit at $Q_1$
  (b) Suppose the market price falls to $25 per pallet. On your graph in part (a), show the new price, labeled $P_2$, and the firm's new profit-maximizing quantity, labeled $Q_2$.
  (c) On your graph in part (a), label the minimum point of the $AVC$ curve as point $A$, and show the price below which Kestrel Pallets would shut down in the short run, labeled $P_{SD}$.
  (d) Suppose Kestrel Pallets expands from 1,000 pallets with the Medium plant to 1,200 pallets with the Large plant. Does this expansion show economies of scale, diseconomies of scale, or constant returns to scale? Explain using the table.