Question

Consider a perfectly competitive firm. When the market price is greater than both the firm's marginal cost and average variable cost, the firm ________.

A Is maximizing profits
B Should shut down
C Should increase its level of output
D Should reduce its level of output

Answer 1

When the market price is greater than both the firm's marginal cost and average variable cost, the firm should continue producing in the short run but exit in the long run.

Step-by-step explanation:

If the market price is equal to average cost at the profit-maximizing level of output, then the firm is making zero profits. We call the point where the marginal cost curve crosses the average cost curve, at the minimum of the average cost curve, the "zero profit point." If the market price that a perfectly competitive firm faces is below average variable cost at the profit-maximizing quantity of output, then the firm should shut down operations immediately. ]

Suppose the market price that a perfectly competitive firm faces is above average variable cost, but below average cost. In that case, the firm should continue producing in the short run, but exit in the long run. We call the point where the marginal cost curve crosses the average variable cost curve the "shutdown point."