Question

“IBM should never sell its product for less than it costs to produce.” If “costs to produce” is interpreted as average total cost, is this correct? If it is interpreted as average variable cost, is it correct? If it is marginal cost, is the statement correct?

Answer 1

The answer to this question can be discussed in two parts.

# Short run

# Long run

LONG RUN

In the long run, a firm has to cover all types of costs in order to be in market. It cannot afford to suffer losses in the long run and remain in the market. Therefore, the statement given in the question is correct whether 'costs to produce' mean average total cost, average varibale cost or marginal cost.

SHORT RUN

In short run there is a difference between variable and fixed cost. A firm needs to cover its variable cost but it may suffer losses to the extent of fixed cost.

Average total cost = average fixed cost + average variable cost

Explaining in detail, In the short run, a firm can either earn normal profits, super normal profits or losses. If the firm is earning losses, the firm will remain in the market till it earns its average variable cost. If it is not earning even average variable cost, then the firm shuts down. Going by this theory, in short run a firm can sell at a price below its average total cost but not below its average variable cost. Therefore, the given statement is incorrect if 'costs to produce' means average total cost. But the statement is correct if the 'Costs to produce' mean average variable cost.

Further, marginal cost is cost of additional unit produced. It should always be covered. In the short run, marginal cost curve starts above the minimum average variable cost, that means marginal cost should also be covered in the short run. Therefore the given statement is correct if the 'costs to produce' mean marginal cost.