Question

2. Refer to the table below to briefly explain whether each firm will continue to produce (operate) or not (shut-down) in the     short-run. Also explain whether each firm will expand or exit the industry in the long-run.

	Firm A	Firm B	Firm C
Total Revenue	800	800	800
Total Cost	800	1200	600
Total Fixed Cost	300	300	300

Answer 1

Let us also add total variable cost, which is calculated as total cost - total fixed cost as follows:

In the short run, if price is less than average variable cost (or total revenue < total variable cost), a firm shuts down production. It can be observed that firm B is not able to cover its variable cost. Hence, it may decide to shut down and other two firms will continue to produce.

If average cost < price in an industry and existing firms enjoy super normal profit, it attracts other firms to enter the industry or it encourages existing firms to expand. This process continues till average cost rises to a level when it is equal to price. In other words, total cost equals total revenue. It can be observed that firm C enjoys super normal profit since TR > TC. On the other hand, firm A earns normal profit where TC = TR. Hence, firm C has incentive to expand in the long run, where firm A will decide to operate at the level it is operating. As mentioned earlier, firm B will exit the industry.