Question

If a firm decides it is in its best interest to shut down in the SR what must be true about: total revenue compared to total cost? Total revenue compared to total variable cost? Price compared to average total cost? Price compared to average variable cost? Answer in depth.

Answer 1

A firm will shut down in short run only if its revenue cannot cover total variable costs, and the firm is incurring a loss. Therefore,

(i) Total revenue (TR) is less than Total cost (TC) (signifying economic loss).

(ii) Total revenue is less than Total variable cost (TVC).

(iii) Price is less than average total cost.

TR = Price x Quantity (Q), therefore Price = TR / Q

TC = Average total cost (ATC) x Q, therefore ATC = TC / Q

Since TR < TC,

(TR / Q) < (TC / Q), i.e.

Price < ATC

(iv) Price will less than Average variable cost (AVC).

AVC = TVC / Q

Since TR < TVC,

(TR / Q) < (TVC / Q), i.e.

Price < AVC.