Final answer:
When the contribution margin fails to cover fixed expenses, a loss occurs. The firm should then evaluate if the market price is above the shutdown point; if not, it's best to halt production and incur only fixed costs as losses.
Step-by-step explanation:
If the contribution margin is not sufficient to cover fixed expenses, then option C, a loss occurs, would be the correct answer. The contribution margin is the amount by which a company's sales revenue exceeds its variable costs, and it is used to cover the company's fixed expenses. If the contribution margin does not cover the fixed expenses, the firm cannot break even, leading to a loss.
The decision to continue production despite suffering losses depends on whether the price is above the shutdown point. The shutdown point occurs at the intersection of the average variable cost curve and the marginal cost curve, indicating the minimum price level a firm must receive to cover its variable costs. Below this point, the firm should shut down operations to minimize losses since revenue would not even cover variable costs, let alone fixed costs. Nevertheless, if the price is above the minimum average variable cost but below the total cost, the firm may continue to operate in the short run to minimize the loss to a level less than the total fixed costs.
If the firm faces a choice of producing at a level where price equals marginal revenue (MR) and marginal cost (MC), or shutting down altogether, it should compare the specific price they receive in the market to their average variable cost. If the price is lower than the average variable cost, the firm should shut down and incur just the fixed costs as losses, which are unavoidable.