Answer to Question #309990 in Microeconomics for jas

Question

Should a perfect competitive firm produce if prices were less than the minimum level of

average variable cost, explain using diagram.

Answer 1

Should a perfectly competitive firm produce if prices were less than the minimum level of

average variable cost, explain using diagram.

The firm is making losses if the market price is below average cost at the profit-maximizing quantity of output. For such a market price, the firm would be better off continuing to operate in the short-run, as its operating losses would be fewer than the losses it would suffer if it shut down.

Consider the upper zone, where prices are higher than the point at which marginal cost (MC) crosses average cost (AC) at zero profit. In the short run, the firm will profit at any price over that level. The firm receives zero profits if the price falls exactly on the zero-profit point where the MC and AC curves cross. If a price falls between the zero-profit point when MC crosses AC, and the shutdown point, where MC crosses AVC, the firm will lose money in the short run, but the losses will be lower than if the firm shuts down immediately since its variable costs are more than covered. Finally, look for a price that is equal to or less than the point when MC crosses AVC. The firm will close down at any pricing like this since it will not be able to meet its variable costs.