Question

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


close down in the short run


a

operate in the short run, even though it will sustain a loss


b

operate in the short run, because it will make an economic profit of $3 per unit


c

operate in the long run, because it will make an economic profit of $3 per unit


d

operate in the short run, but decrease output to decrease its cost

Answer 1

b — operate in the short run, even though it will sustain a loss.

Reason: price = MR = $12, which is above the shutdown point (min AVC = $10) so the firm covers variable costs and should continue producing. But price is below min ATC = $15, so the firm incurs a loss of $15 − $12 = $3 per unit.