Question

Explain why firms do not immediately go out of business if total revenue fails to cover total costs of production

Answer 1

a firm must have revenue R ≥ TC, total costs, in order to avoid losses. However, in the short run, all fixed costs are sunk costs. Netting out fixed costs, a firm then faces the requirement that R ≥ VC, variable costs, in order to continue operating. Thus, a firm will find it more profitable to operate so long as the market price p ≥ AVC, average variable cost. So in the short run a firm should continue to operate if price exceeds average variable costs.