This question concerns a perfectly competitive firm. The information given, that "Mike's needs only workers and the factory to produce baseball caps", is meant only to make sure you don't make the question more complicated than intended.

The question asks how many caps the firm will produce if the market price is P₁? From the graph we see that, at price P₁ P = MC when the firm is producing Q₁ units of output; so this seems, at first, like the correct answer. However, we know that even in the short run a firm will produce no output when P < AVC as is the case here. Thus, the firm will produce no output whatsoever.

1. Q₁ would be correct if P > AVC.
2. Q₂ Since the price is P₁ this would be overproduction, and would make the firm worse off than producing Q₁.
3. Q₃ Since the price is P₁ this would be overproduction, and would make the firm worse off than producing Q₁.
4. Q₄ Since the price is P₁ this would be overproduction, and would make the firm worse off than producing Q₁.
5. 0 Correct!