7. In the short run, firms are expected to shut down if the price they receive...

7. In the short run, firms are expected to shut down if the price they receive is less than their AVC. In the long run, firms are expected to exit if the price they receive is less than their ATC. Explain why this difference occurs.

Expert Solution

In the short run,the firm is required to shut down if the price they receive is below the AVC however in the long run,it is required that the price must be below their ATC for them to shutdown.The ATC comprises both Average variable cost and Average fixed cost.This difference exist because in the short run,all the fixed costs are regarded as sunk cost and the firm is unable to recover them so only the variable cost matters and as long as the firm is able to recover its variable cost or the price is above their AVC,they would continue to operate because they are able to meet their cost of production of running the business.

Whereas in the long run,the firm should be able to meet its ATC as in the long run,all the factors can be changed and so the firm can change its production by changing its variable as well as its fixed factors of production so,it is incurring costs on its fixed factors too which should be met in order for the firm to continue to recover its total cost of production and continue to run the business.

Rahul Sunny answered 2 years ago

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