Question

Question 19 In a perfectly competitive market, a firm may have losses in the short run. Suppose the firm’s total costs are $1,000 and fixed costs are $200 when outputs are 100. The market-determined price of the good is $9 per unit. Which of the following statement is true?

a. The price is less than the average variable cost

b. The firm should shut down business

c. The firm should continue doing business

d. The price is less than average fixed cost

Answer 1

Answer - C. The firm should continue doing business.

The firm is operating in the short run. The firm is producing output of 100 units. Lets assume it is the profit maximizing output. At this output, the price (MR) is $9 per unit.

From the above, it can be seen that at the given output level, the Total Cost is $1,000 and Fixed Cost is $200.

As we know that TC is the combination of Fixed and Variable cost, in the given question the variable cost will be $800.

TC = FC + VC

$1,000 = $200 + VC
VC = $800.

Calculate the Average Total Cost and Average Variable Cost

ATC = TC / Quantity

ATC = $1,000 / 100 = $10

AVC = VC / Quantity

AVC - $800 / 100 = $8

It is clear from the above that the firm is incurring losses because the Price is less than the ATC (PATC). But is can be seen that the price is greater than the average variable cost (PAVC). Any price below that AVC, the firm will shut down in the short run. But here the firm will continue to operate in the short run because the price is more than the average variable cost. If the firm shuts down then the loss will be equal to Fixed Cost and it will be more than the loss if the firm continue to produce.

Therefore, in the given condition the firm should continue to doing the business.