A rm receives the same price $P for each unit of output it produces and sells. i

Question

A rm receives the same price $P for each unit of output it produces and sells. i.e. it is a price taker. $P < ATC(Q) means negative prots at the output level. Assume that the rm is operating at Short Run. Explain why, for the rm, producing Q > 0 units of output, operating when P shutdown < $P < ATC (Q) is a rational choice. A rm receives the same price $P for each unit of output it produces and sells. i.e. it is a price taker. $P < ATC(Q) means negative prots at the output level. Assume that the rm is operating at Short Run. Explain why, for the rm, producing Q > 0 units of output, operating when P shutdown < $P < ATC (Q) is a rational choice.

Explanation / Answer

This is explained when we consider that total cost is divided into variable and fixed costs.

Even if the firm shuts down in short run, it has to incur the fixed costs. Therefore, even if price is less than average total cost and there is a long-run economic loss, the firm should operate in the short run if its price can recover the average variable costs, i.e. Price > Average variable cost.

Therefore, for a price-taking firm, the lowest point of average variable cost curve is called the shut-down price since if price falls below this level, the firm shuts down.

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