Question

Sally's rocket store is experiencing fierce competition in a perfectly competitive market. The market price for a rocket is less than her ATC of producing the profit maximizing quantity, but greater than AVC. Sally should:

a.) Produce in the short run, and produce in the long run.

b.) Produce in the short run, and exit in the long run.

c.) Shutdown in the short run, and produce in the long run.

d.) Shutdown in the short run, and exit in the long run.

Answer 1

In short-run, a perfectly competitive firm continues to operate and produce if the market price is greater than the AVC corresponding to the profit-maximzing quantity. However, in the short-run, if the market price is less than the AVC corresponding to the profit-maximzing quantity then the firm shuts down.

In long-run, a perfectly competitive firm continues to operate and produce if the market price is greater than the ATC corresponding to the profit-maximzing quantity. However, in the long-run, if the market price is less than the AAC corresponding to the profit-maximzing quantity then the firm exit the market.

In the given case, market price is less than ATC but greater than AVC corresponding to the profit-maximizing quantity.

So, Sally should produce in the short-run, and will exit the market in the long-run.

Hence, the correct answer is the option (b).