Answer to Question #308722 in Microeconomics for Frank Mensah

Question

Explain why a perfectly competitive firm will not shut down in the short run when making losses. Illustrate the answer with an appropriate diagram

Answer 1

Explain why a perfectly competitive firm will not shut down in the short run when making losses. Illustrate the answer with an appropriate diagram

Shutting down can decrease variable expenses to zero, but the company has already paid for fixed expenditures in the near term. As a consequence, even if the corporation produces no quantity, it will still lose money since it must pay for its fixed expenditures.

Assume that the firm's profit-maximizing quantity Q₁ is at a specific market price P₁. If the firm's average variable cost curve is below its marginal revenue curve, it may elect not to shut down in the short run while it is losing money (the flat dashed line denoting the price level). It indicates that the company is able to pay its variable costs. The dashed rectangle region in the diagram represents the firm's losses. As a result, despite the losses, the business will not shut down in the short term since it gets enough income to cover its variable costs, as shown in the diagram.