Question

True/False with explanation: If a firm is losing money, and there is no change in the market on the horizon to lead it to believe that the situation will improve, it should immediately shut down to avoid further losses.

Answer 1

True.

If a firm makes only short run loss such that price is less than ATC, but is higher than AVC, then it continues production if there is any future possibility that the situation will improve, so that price may exceed ATC in long run, thus the firm will no longer incur a loss (and may possibly earn profits).

But if a firm makes only short run loss such that price is less than ATC but there is no future possibility that the situation will improve, then even in long run, price is likely to be lower than ATC and thus the firm will never earn profit or stop incurring loss. So, instead of continuing with such loss, the firm will avoid the fixed costs if it immediately shuts down.