ll market firms must be able to answer the following three questions. 1. How muc

Question

ll market firms must be able to answer the following three questions. 1. How much output should we produce? 2. What Price should we charge? 3. If we are making a loss, should we shut down or continue to operate? Let look at the Decision Rule for the decision to shut down or continue to operate. The decision rule in your study explains that the firm should continue to operate if TR (Total Revenue) is greater than TVC (Total Variable Costs) (TR>TVC), and Shut Down if TR < TVC. How does this relate to operation in the short run vs the long run operation? (Hint: notice the decision rule regards TVC & remember R=P*Q). In the long run, are all Costs Variable?

Explanation / Answer

In the short run, a profit-maximizing firm will increase production if marginal cost is less than marginal revenue, decrease production if marginal cost is greater than marginal revenue, continue producing if marginal variable cost is less than price per unit, even if average total cost is greater than price, shut down if average variable cost is greater than price at each level of output.

In the long run, a firm can enter an industry in response to expected profits, leave an industry in response to losses, increase its plant in response to profits, decrease its plant in response to losses.

Factors of production, such as labor, land, and capital, are variable in the long run since firms can choose to increase or decrease investments and production and even to shut down business.

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