Question

A perfectly competitive firm currently producing 100 units of output has ATC= $6 and AFC = $4. The market price is $3 and is equal to MC. Is the firm currently operating in the short-run or the long-run? Explain why. Discuss if the firm is currently maximizing profits (or equivalently minimizing losses)? Explain if shutting down the business in this current situation would be beneficial for the firm. If firms break even in the long run and earn zero economic profits, would they stay in the business? Explain why.?

Answer 1

Is the firm currently operating in the short-run or the long-run? Explain why.

Ans: short run.

Because in short run at least one cost is fixed. And long run all cost are variable. So, here AFC is given that means firm is in short run.

Discuss if the firm is currently maximizing profits (or equivalently minimizing losses)?

Yes. Minimising losses.

Firm maximises it's profit where MR equals MC and in perfect competition price is equals to MR. Here MC and price are equal so it is minimising losses.

Explain if shutting down the business in this current situation would be beneficial for the firm.

Ans:

No!

Firm should shutdown when price is less than average variable cost.

AVC =ATC-AFC

=6-4

=2.

So, price is not less than AVC so, firm will produce.

If firm produce, loss will be equal to

Profit =(Price - ATC) *quantity

=(3-6)*100

=300.

But if not produce loss will be equal to fixed cost.

Fixed cost =AFC *quantity

=4*100

=400.

If firms break even in the long run and earn zero economic profits, would they stay in the business? Explain why.?

Yes!

In long run perfectly competitive firm earns zero economic profit.

They will stay because they earns accounting profit even if they are making 0 economic profit.

Because economic profit =total revenue - explicit cost - Implicit cost

Accounting profit =total revenue - explicit cost.