Question

In a perfectly competitive industry how might a firm earning negative profits not shut down?

Answer 1

In a perfectly competitive industry,if a firm is incurring losses,it may continue to operate if the amount of revenue offsets the amount of fixed costs and a part of variable costs;in which case the loss may be diminished if the firm continues to operate.For example, consider the market for accountants,if the amount of rent (ie fixed cost) is $1000 and the cost of hiring interns and office staff is $1200.In this case a firm may earn either no revenue,revenue which covers the fixed cost or revenue which covers the fixed cost and a part of variable cost.

In case a firm earns no revenue,it must shut down to avoid the variable costs and increase losses since fixed costs shall be payable in any case.

In case a firm earns revenue equal to fixed costs by hiring staff (ie by increasing the variable costs),it must shut down since increase in the variable cost only increases losses.

However in case the firm earns revenue to cover the fixed costs wholly and partially the variable costs also,it may continue to operate since the revenue is enough allow incentive to continue and the loss can be diminished over time with continued operations.

For example the revenue of the accounting firm is $1050 and it's fixed expenses are $1000 and the cost of hiring staff is $1200.In this case,loss of $150 can be diminish over time if the firm continues to operate.Therefore,it shall not choose to shut down.