Question

Under what condition will a competitive firm necessarily shut down its operations? What does this imply regarding the shape of the firm's short run supply curve?

Answer 1

Answer on Question #89225, Economics / Microeconomics

QUESTION: Under what condition will a competitive firm necessarily shut down its operations? What does this imply regarding the shape of the firm's short run supply curve?

ANSWER: The rising portion of the MC curve above the minimum of AVC curve is the supply curve of an individual firm under perfect competition. The short run supply decision of a competitive firm depends upon the least price it will accept to continue supplying the output and the price at which it will shut down.

As long as the Average revenue exceeds the average variable costs, i.e. AR > AVC (or TR > TVC) at the equilibrium output, a smaller loss will be incurred if the production takes place and firm will continue to produce. But if the price falls below AVC, the firm will discontinue its operations and will shut down. The minimum of AVC curve is the shutdown point as neither the variable costs nor any part of the fixed costs will be coverable at this point.

As a result, the rising portion of MC curve which is above the minimum of AVC curve is the supply curve of the competitive firm and it is upward sloping from left to right showing that a competitive firm will supply greater quantities of output at higher prices and less quantities will be supplied at lower prices, other things being constant.

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