Explain why a firm only shuts down once the price drops to the minimum of the...

Explain why a firm only shuts down once the price drops to the minimum of the average variable cost (AVC) curve, rather than shutting down as soon as the price falls below the minimum of the average total cost (ATC) curve.

Expert Solution

As soon as the price falls below the minimum of the average variable cost, this means that the firm is not able to recover it's variable cost like the payment made to workers. So the firm is not able to cover the fixed cost as well as the variable cost. When the firm decides to shut down which means it will produce zero output then the variable costs are zero but there is a fixed cost that the firm needs to bear. When the price falls below the minimum of the average total cost curve then it means that the firm is able to recover it's variable costs but it is making losses. Shutting down when price falls below the minimum of the average total cost curve means that the firm will incur more losses. So a firm shuts down when price falls below the minimum of the average variable cost curve.

Rahul Sunny answered 2 years ago

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