Figure 14-1Suppose that a firm in a competitive market has the following cost curves:Refer to Figure 14-1. The firm should shut down if the market price is

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Figure 14-1Suppose that a firm in a competitive market has the following cost curves:​Refer to Figure 14-1. The firm should shut down if the market price is

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To decide whether a firm in a competitive market should shut down in the short run, we compare the market price to the firm’s variable costs in the short run. The key concept is the shutdown rule: a firm will produce as long as price covers average variable cost (P >= AVC) and will shut down if price falls below the minimum point of the AVC curve (P < min AVC).

Option 1: above $6.5. This is clearly not the shutdown price. If the price is this high, the firm can cover its average variable costs and likely earn positive operating profit (subject to fixed costs). So this is not the correct shutdown condition.

Option 2: above $3 but less than $6.5. In this range, the price is above the minimum AVC (as depicted near P ≈ $3 on the graph) but may still be below the average total cost at the current output. The firm can cover its variable costs and part of its fixed costs, so it would choose to produce rather than shut down. Therefore, this is not the shutdown price.

Option 3: above $6.5 but less than $10. Here the price is well above the minimum AVC, and production is certainly covering variable costs; the firm would operate. This option does not indicate a shutdown scenario.

Option 4: less than $3. This is the critical case. The graph shows the minimum point of the AVC curve occurring at about $3. When the market price falls below this minimum AVC, the firm cannot cover its variable costs and should shut down in the short run to minimize losses. Any production would add losses beyond those incurred by fixed costs, so shutdown is the rational choice at P < min AVC.

In summary, the shutdown condition hinges on whether price falls below the minimum average variable cost. Since the minimum AVC is about $3 in the figure, prices below $3 trigger shutdown, while higher prices allow production depending on how they compare to ATC.

Microeconomics Week 4 Quiz Microeconomics Week 4 Quiz

Figure 14-1Suppose that a firm in a competitive market has the following cost curves:Refer to Figure 14-1. The firm should shut down if the market price is

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Microeconomics Week 4 Quiz Microeconomics Week 4 Quiz

Figure 14-1Suppose that a firm in a competitive market has the following cost curves:​Refer to Figure 14-1. The firm should shut down if the market price is

View Explanation

Log in for full answers

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