Question

consider this statement: In the short run, if i can cover my variable costs, i will continue to produce, ignoring my fixed costs. If i cannot cover my variable costs, i will shut down to minimize losses. Is this statement accurate? why or why not?

Consider this statement: In the long run, if i can cover my variable costs, i will continue to produce. If i cannot cover my variable costs, i will shut down. Is this statement accurate? why or why not?

Answer 1

solution:

a.) the statement is TRUE.

If P denotes the market price of the product and Q denotes the number of units produced and sold, then PxQ is the firm’s total revenue from sales, and if we use VC to denote the firm’s variable cost, the rule is that the firm should shut down in the short run if PxQ is less than VC for every level of Q.  on the Firm’s Shut-Down Condition
It might seem that a firm that can sell as much output as it wishes at a constant market price would always do best in the short run by producing and selling the output level for which price equals marginal cost. But there are exceptions to this rule. Suppose, for example, that the market price of the firm’s product falls so low that its revenue from sales is smaller than its variable cost at all possible levels of output. The firm should then cease
production for the time being. By shutting down, it will suffer a loss equal to its fixed costs. But by remaining open, it would suffer an even larger loss.

b.) This statement is FALSE. Shutdown point and break-even point are the same in the long run: the minimum point of ATC curve (compare to the shutdown point in the short run: the minimum point of AVC curve). In the long run a minimum of normal profit is needed to remain in a market for a particular product. This occurs when P=AC (i.e. the price covers both fixed and variable costs).