Question

When a firm operates in the short run, what must be true for them to choose to shut down (produce 0 output)? What must be true for the firm to produce a non-zero level of output? How do they choose what level of output to produce?

Answer 1

In competitive market when firms operate in the short run and price is below the minimum of average variable cost, they must choose to shut down.

In short run if price is above the min(AVC), they should continue their production. Case 1: if min(ATC)>p>min(AVC) . The firms should continue their production though there are losses. As in the long run they can overcome the loss when some firms will exit, price will be increased. Therefore they will produce non zero output

Case2: if P>min(ATC), firms making profit so they will surely continue the production. Therefore they will produce non zero output.

Firms will decide their production where profit is maximized. In competitive market profit is maximized at P=MC=min(ATC). Firms will choose to produce at P=MC. If now P>min(ATC) there will be profit and if P<min(ATC) there will be loss. In the long run they will earn normal profit as price will be equal to min(ATC). So firms will choose to produce output where P=MC.