Final answer:
The statement is true as a firm near its break-even point has a lower proportion of fixed costs, leading to a lower degree of operating leverage. A firm should continue operating above the average variable cost, even if it makes losses, to minimize losses.
Step-by-step explanation:
The statement 'The closer a firm is to its break-even point, the lower the degree of operating leverage it will be' is true. Operating leverage is a measure of how revenue growth translates into growth in operating income. It is determined by the proportion of fixed costs to variable costs in a company's cost structure. A high degree of operating leverage shows that a firm has more fixed costs compared to variable costs, which means that a small change in sales can lead to a large change in operating income. As a company approaches its break-even point, the proportion of fixed costs in the total costs decreases, leading to a lower degree of operating leverage.
When considering whether a firm should continue operating when it is making losses, the key principle is whether the firm is covering its average variable costs (AVC) with the price of the product. If the price is above AVC but below the average cost (AC), the firm will still operate in the short run to cover its variable costs and minimize losses. However, if the price falls below AVC, the firm will choose to shut down since it cannot cover the variable costs, and continuing to operate will only increase losses.
At the break-even point, where marginal cost (MC) crosses AC, the firm earns zero profits. If the price is in the zone between the shutdown point (where MC crosses AVC) and the break-even point, the firm is incurring losses. It should, however, continue operations if the price is above the shutdown point, as it is better to cover partial costs than none at all and incur greater losses.