Suppose a profit-maximising firm in a competitive market is unable to generate enough revenue to pay all of its fixed costs. In the short run it should:

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BlackTom AI · Accepted Answer

To analyze the scenario, we first recall the short-run decision rule for a perfectly competitive firm: a firm should continue producing as long as it can cover its variable costs, even if it cannot cover all fixed costs, because fixed costs are sunk in the short run.
Option 1: 'continue to produce as long as marginal cost is less than average revenue.' In perfect competition, price equals marginal revenue, so this would imply producing while MR > MC; however, the criterion should be about covering variable costs, not just comparing MC to AR. This option misstates the standard shutdown condition and focuses on marginal cost vs average revenue rather than average variable cost.
Option 2: 'continue to produce as long as revenue is sufficient to pay variable costs.' This aligns with the shutdown rule: as long as price (and thus revenue per unit) covers average variable costs, the firm can cover its variable costs and contribute something toward fixed costs, making production preferable to shutting down when fixed costs cannot be fully recovered in the short run.
Option 3: 'continue to produce and lower its price to gain more market share.' In a competitive market, the firm is a price taker and cannot sustainably lower price to gain market share; lowering price would reduce revenue and may not cover variable costs, potentially making the situation worse.
Option 4: 'shut down and incur the total loss of its fixed cost.' This would be appropriate only if revenue could not cover even variable costs (i.e., price < average variable cost). The problem statement indicates the firm cannot pay all fixed costs but does not state that variable costs cannot be covered, so shutdown is not the required move here.
Therefore, the reasoning supports option 2 as the appropriate short-run decision under these conditions.

Suppose a profit-maximising firm in a competitive market is unable to generate enough revenue to pay all of its fixed costs. In the short run it should:

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Suppose a profit-maximising firm in a competitive market is unable to generate enough revenue to pay all of its fixed costs. In the short run it should:

View Explanation

Log in for full answers

Similar Questions

Assume that, for a perfectly competitive firm, marginal cost equals average variable cost at $10, marginal cost equals average total cost at $15, and marginal revenue equals marginal cost at $12. On the basis of this information, the firm should

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