Question

Q3) Explain, with the aid of graph(s), why profit maximization for a firm is a perfectly competitive market implies that the short-run shutdown point is at the quantity where

p=AVC(q).

Answer 1

Ans. The difference between the average variable cost and average total cost is the average fixed cost (because ATC = AFC + AVC) and profit per unit is the difference between price and the average variable cost. So,

Profit per unit = Price - (AVC + AFC)

If price of the good equals the AVC, then,

Profit per unit = AVC - AVC - AFC = -AFC

=> Firm incurs a loss per unit of AFC (Total fixed cost = AFC * quantity) and firm shuts down then also, its loss will be fixed cost but if the price is greater than the the AVC then, the firm's loss decreases and if price is less than AVC and firm ia still producing then loss increases beyond fixed cost. So, it is beneficial for the firm to supply the good if and only if price is greater than or equal to the AVC.

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