Question

When price is less than average variable 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

Answer: (D)

shutdown, since it cannot even cover its variable costs if it stays in business.

In a competitive market, the firm maximize it's profit when the market price of the firm is equal to average variable cost of the firm so that the firm earns normal profits in the long run.

Therefore, if price is less than the average variable cost then the firm should shutdown.