Question

Each of the following situations could exist for a perfectly competitive firm in the short run. In each case, explain whether the firm should produce in the short run, shut down in the short run, or whether additional information is needed to determine what it should do. a. Total costs exceed total revenue at all output levels. b. Marginal revenue exceeds marginal cost at the current output level. c. Price exceeds average total cost at all output levels. d. Average variable cost exceeds price at all output levels.

Answer 1

Answer: a) More information needed

b) Produce in short run

(c) Produce in short run

(d) Shut down in short run

Explanation:

a) More information needed

In the short run if TC exceeds TR then the firm is incurring a loss. However if TR is still greater than AVC then the company will not shut down as the condition for shutting down has not been met which is that Price should be less than Average Variable Costs and this information is not known.

(b) Produce in short run

In a Perfect Competition, price is the same as Marginal Revenue which means that if MR is greater than MC then Price is greater than MC as well. This means that the Average Variable cost is less than Price as well so they will keep producing as opposed to shutting down.

(c) Produce in short run

If the Price exceeds the Average Total cost at all output levels then that means that profit is being made. The firm will therefore keep producing in the Short run.

(d) Shut down in short run

If Variable costs are more than the Price then the firm is unable to fund operations as they can't even cover variable costs. This will mean that they would have to shut down in the Short run.

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