Chapter 11R, Problem 9MCQ

To determine

The correct option for given situation where firm has to decide whether to continue the business if selling price is above average variable cost and below average total cost. Also, marginal revenues at this output level are equal to marginal cost.

Answer to Problem 9MCQ

Option d is correct answer.

Explanation of Solution

Explanation for correct option:

d.

The firm should continue to produce at the level where prices are equal to or above the average variable cost because if firm is shut down where it is covering its variable cost at least then fixed cost is required to be paid irrespective of output level. For instance, firm is shut down then the firm will make only losses and its fixed cost will be treated as sunk cost. Therefore, option d is correct.

Explanation for incorrect options:

a.

As per the shut-down rule, in short-run the firm should continue its production until the market price is equal to the average variable cost. If the firm is shut-down then the firm’s losses will become unrecoverable. Therefore, option a is incorrect.

b.

Firm can earn profit if market price of the product is raised but in perfect competition, the firm will not be able to sell their products at higher price which does not allow the firm to cover its VC even. Therefore, option b is incorrect.

c.

Firm should continue to produce as it is covering its AVC. If it shut down the firm, then the loss per unit will become equivalent to average fixed cost. Therefore, option c is incorrect.

e.

The firm should continue to produce as its average variable cost is covered even if the firm is not making profit it is recovering the fixed cost. Therefore, option e is incorrect.

Economics Concept Introduction

Average total cost: Average total cost of production per unit is comprised of two cost components that are average fixed cost and average variable cost. In short-run, fixed cost of the production remains similar.