Question

15. When the price received for a good is less than average variable costs: O a. The firm is earning negative profits. b. The firm should shut down immediately. c. The firm should remain open until after fixed costs are covered, and then shut down. Od. a and b Oe. a and c

Answer 1

A firm will choose to implement a production shutdown when the revenue received from the sale of the goods or services produced cannot cover the variable costs of production. In this situation, a firm will lose more money when it produces goods than if it does not produce goods at all. Producing a lower output would only add to the financial losses, so a complete shutdown is required. If a firm decreased production it would still acquire variable costs not covered by revenue as well as fixed costs (costs inevitably incurred). By stopping production the firm only loses the fixed costs.

Economic shutdown occurs within a firm when the Price  is below average variable cost at the profit-maximizing output. The goal of a firm is to maximize profits and minimize losses. When a shutdown is required the firm failed to achieve a primary goal of production by not operating at the level of output where Price equals marginal cost. In such cases firm have both negative profits and will immediately shut down .

Hence ( D ) part is a correct answer