Question

Discuss why a firm may decide to continue producing a good even if its price may be less than the average total cost. (Hint: Refer to the shut-down point and provide a real-world example so others can come up with different examples).

Answer 1

At the shutdown point revenue equals variable costs. The firm at this point is minimizing losses or maximizing profits.

Though the firm is making losses at the shutdown point, it will continue to operate because the fixed costs are already incurred.

Any profit will go towards reducing the fixed cost. If the revenue falls below AVC, then the firm should shut down its operations.

When a new product is launched or if the start-up expenses are very high, a firm may continue to operate at the shutdown point. In periods of recession, a firm may resort to this type of pricing.