Question

A firm faces the shut down situation when __________.

• A. price is less than average variable cost
• B. price is more than the average variable cost
• C. price is equal to fixed cost
• D. price is more than the average fixed cost

Answer 1

Answer: (A)

price is less than average variable cost

In short-run market conditions, there are two types of cost incurred by a firm; a Fixed cost that does not depend on the production of output, and variable cost which depends upon the production of output.

There if the price is equal to the average variable cost then the firm would incur losses of fixed cost which the firm would anyway incur if they chose not to produce anything.

But if the firm is recurring losses for a variable cost where the price is less than the average variable cost then the firm must shut down in order to avoid such losses.