CFA Practice Question

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CFA Practice Question

Refer to the graph below. If market price decreases from $7.00 per unit to $6.00 per unit, a profit-maximizing firm will ______.

A. increase output from 650 to 750.
B. decrease output from 850 to 750.
C. produce 850 units of output.
Correct Answer: B

The firm maximizes profit by setting price equal to marginal cost.

User Contributed Comments 4

User Comment
zeiad good answer
schweitzdm I am quite confused as to why the answer isn't also (A).

In both (A) and (B), the firm would be setting price equal to marginal cost, just as this answer describes, right?
kay136 schweitzdm: the key words of the question are "profit maximizing firm". Because it's a profit maximizing firm, it would have been producing 850 prior to the decrease in price.
Huricane74 @schweitzdm
The market price was initially $7, so at that price, the firm would have been producing 850 units.
Once the market price declined from $7 to $6, a profit maximizing firm would no longer produce units at a marginal cost that exceeds the new market price.
To align the marginal cost with the market price, and based on the graph above, the firm needs to reduce production from 850 units to 750 units.
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