Question

In: Economics

Explain why a perfectly competitive firm will shut down in the short run if price is...

  1. Explain why a perfectly competitive firm will shut down in the short run if price is lower than average variable cost but will continue to produce if price is below average total cost but above average variable cost.
  1. In long-run competitive equilibrium, P = MC = SRATC = LRATC. Because P = MR, we can write the preceding condition as P = MR = MC = SRATC = LRATC. The condition thus consists of four parts: (a) P = MR, (b) MR = MC, (c) P = SRATC, and (d) SRATC = LRATC. Part (b)—MR = MC—is true because the perfectly competitive firm attempts to maximize profits, and that equation represents how it does so. What are the explanations for (a), (c), and (d)?
  1. P = MR because,
  1. MR = MC because,
  1. P = SRATC, because
  1. SRATC = LRATC because

Solutions

Expert Solution

Shutdown decision is taken if the price is less than the minimum of average variable cost. this is because it indicates that the revenue earned by the firm is not sufficient to cover the variable cost and it is also not able to cover the fixed cost because it is less than the average total cost. therefore when the price is less than the average variable cost as well as average total cost, firm decides not to continue production because by stopping production and leaving in the long run it can prevent the fixed cost.

Price is equal to marginal revenue because for each additional unit sold firm is able to receive the additional revenue which is equal to the price. This happens because firm has no control over the price and it has to sell every unit at the same price

Marginal revenue is same as marginal cost for competitive firm in the long run because profit maximization results in MR = MC

Price is same as short run average total cost because the minimum of short run average total cost is determined in the long run and entry and exit by firms result in price getting equal to average total cost

short run and long run average total cost both are equal to each other in the long run because there is no fixed factor and all factors are variable due to which there is no fixed cost in the long run.


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