Question

Given the following three scenarios, when do you produce and why (Note, you are in the short run)? 1) Market Price above Minimum AC 2) Market Price between AC and AVC 3) Market Price is Less than the minimum AVC

Answer 1

A firm will produce unless price is greater than or equal to minimum average variable cost, AVC in the short run. If price goes below AVC the firm is not even able to cover variable cost, then decides to shut down.

1) produce

When price is above minimum AC. It means it must be greater than AVC as AC is always greater than Minimum AVC. So it produces.

2) produce

When Price is between AC and AVC, Price is at least greater than Minimum AVC , which implies it will produce.

3) not produce

When price is Less than Minimum AVC, it is not only unable to cover fixed cost but also can not cover variable cost. This means the firm will shut down even in short run.