Question

Is the following statement TRUE, FALSE or UNCERTAIN: Once a firm has built its plant and purchased its machines (capital), the firm should always operate (produce output)? EXPLAIN your answer.

Answer 1

The above statement is FALSE.

This is because the plant purchased is a part of the "sunk" cost (also known as fixed costs / overhead costs) and is taken into consideration while calculating the Long-run average total cost of the firm.

On the other hand, whether a firm decides to operate or not depends upon its variable cost of production.

If AVC <p, the firm will continue to operate (produce output). However, when AVC >P, the firm will cease to operate and shut down, This is because the firm is unable to cover even its variable cost of operation, let alone fixed costs.

Hence, whether a firm should always produce output or not depends upon the AVC and Price of the firm.