Question

When price is less than avenge vairable cost at the profit-maximising level of output, a firm should :

• A. Produce where marginal revenue equals marginal cost if it is operating in the short run.
• B. Produce where marginal revenue equals marginal cost if it is operating is the long run.
• C. Shutdown, since it will lose nothing in that case.
• D. Shutdown, since it cannot even cover its variable costs if it stays in business.

Answer 1

The correct option is D Shutdown, since it cannot even cover its variable costs if it stays in business.

When P<AVC at the profit maximising level of output i.e. (MC=MR) then a firm shut down because the firm is incurring loss of both fixed as well as variable cost and a firm should shutdown his business if it cannot even cover its variable costs.