A firm never operates

Question

BlackTom AI · Accepted Answer

The prompt states the claim: 'A firm never operates on the downward sloping portion of its AVC curve.' To evaluate, we need to recall how average variable cost (AVC) typically behaves. AVC is generally U-shaped: it decreases at low output, reaches a minimum, then increases as output rises due to spreading fixed costs and then rising marginal costs. The critical decision rule for a firm in the short run is to produce if price (P) covers average variable cost (AVC), i.e., P >= AVC at the chosen output level; if P < AVC, the firm should shut down.

Option analysis:
- If the statement claims 'never operates on the downward sloping portion,' this asserts the firm will not produce when AVC is falling as output increases. However, nothing in the shutdown decision prohibits production while AVC is falling. In the early or mid-range of output, AVC can be decreasing; if the market price is still at or above the AVC during that range, the firm may operate there because production is covering variable costs and contributing to fixed costs, which is rational in the short run.
- The shape of the AVC curve being downward sloping at some output levels simply reflects decreasing average variable costs due to efficiencies or spreading fixed costs over more units. It does not imply that production is infeasible there. The profitability or viability depends on price relative to AVC, not on the slope of AVC alone.

Common misconceptions addressed:
- Thinking that a downward-sloping AVC would force non-production ignores the fundamental criterion P >= AVC. A firm can and often does operate where AVC is falling, provided price covers costs in the relevant range.
- Assuming a U-shaped AVC means production is restricted to the upward-sloping portion ignores the possibility that the minimum AVC occurs at some output and the firm might still produce on the left side (where AVC is decreasing) if profitable relative to price.
- Misinterpreting marginal costs: even if MC is below price and AVC is falling, production continues to be profitable in the short run as long as price exceeds AVC; the slope of AVC is a consequence, not a restriction, of the cost structure.

In summary, the statement is not generally correct. Firms may operate on the downward-sloping portion of their AVC curve as long as they can cover their variable costs with the market price (P >= AVC). The decision rule hinges on price relative to AVC, not on the direction of AVC's slope alone.

ECON 4001.01 SP2025 (19496) Week 7 quiz

A firm never operates

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