Under what conditions should a firm shut down production in the short run? Under

Question

Under what conditions should a firm shut down production in the short run? Under what conditions should a firm shut down in the long run? Explain the difference between the short and long run conditions

Explanation / Answer

Short Run Decision In the short run, a profit-maximizing firm will: increase production if marginal revenue is greater than marginal cost decrease production if marginal revenue is less than marginal cost The shutdown rule is that in the short run a firm should continue to operate if price is greater than average variable costs. In the short run a firm must earn sufficient revenue to cover its variable costs. When a firm shuts down operation, it does not incur any variable cost. However, the firm still has to bear its fixed costs. Because fixed cost must be paid irrespective of whether a firm operates or not, fixed costs should not be considered in deciding whether to produce or shutdown. Total variable cost/Quantity = Average variable cost (AVC) Total Fixed cost/Quantity = Average Fixed cost (AFC) Average variable cost (AVC) + Average Fixed cost (AFC) = Average total cost or Average cost (ATC/AC) 1. When P > AVC, the firm is covering all variable cost plus there is additional revenue or contribution, which can be applied to fixed costs. The size of the fixed costs is not relevant in this regard as it is already spent. a) P AC - the firm is making economic profit. The firm will continue production. 2. P = AVC - Whole fixed cost remains uncovered, but covering the whole variable cost. The firm will continue production. 3. P

Related Questions

Navigate

• Browse (All)
• Browse U
• Subjects

---

---

Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.