Question

[Can someone explain how the answer is derived----I want to say the answer is fall because price is greater than average variable cost. Is this correct?]

You are given the following information about a firm: Price [20] Marignal Cost [15] Marginal Revenue [10] Average Variable Cost [5] Average Total Cost [25]

If the firm shuts down (short run), profit will

a. rise b. fall c. remain constant d. uncertain

If the firm exits (long turn), profit will

a. rise b. fall c. remain constant d. uncertain

Answer 1

Firms take the decision whether to shut down or continue on the basis of average variable cost in the short run. If P<AVC then the firm will shut down. But profit is calculated by Price and average total cost.

If the firm shuts down in short run, profit will uncertain because of P>AVC, by continuing production it can make up the fixed cost in the long run. So option d is right.

If the firm exits, in the long run, it no longer produce because of P>ATC. If it would continue production it will make a loss. So after exit market pushes up the price and profit will rise. So option a is right.