Question

if a firm makes negative economic profit, then the firm

A) has total revenues greater than its economic costs

B) can be earned positive accounting profit

C) must have no fixed costs

D) must shut down immediately

Answer 1

The solution is option(B) can be earned positive accounting profit.

This is because accounting profit = Revenue - explicit costs, while economic profit = revenue - explicit cost - opportunity costs. Since, economic profits includes an additional cost (opportunity cost),it is always less than accounting profits. So, even when economic profits are negative , there can be positive accounting profits.

(A) option is wrong as, when a firm is making negative economic profits, it implies that total revenue will be less than economic costs.

(C) option is also wrong as fixed costs are incurred even before production starts and profits/losses occur after production and sales. So a firm incurring losses may or may not have had fixed costs. That is, fixed cost is already incurred before firm earns profit/loss. So it is not necessary that it must not have had fixed costs.

(D) is also not entirely correct because a firm incurs negative economic profits when price is less that average total costs. But even in such a case the price may be above the average variable costs, and the firm will continue to operate in the short-run as it is able to cover average variable costs. If price is less than even average variable costs, then only firm must shut down immediately. So, negative profits doesn't not imply that firm must shut down immediately. It can still operate if prices are above average variable costs.