Question

What can managers do to avoid shutting down its business in the short run and what are some of the challenges faced by managers in the long run in a perfect market.

Answer 1

In a perfect competitive market, a multiproduct firm can produce upto the point where marginal revenue is above the average variable cost of the product. Even if one product has marginal revenue below average variable cost, the firm can still continue and do not shut down as it can cover from the other product offerings.

As the firm knows the marginal revenue and average variable cost of its products very well, it can produce up to the point where the marginal revenue is above the average variable cost. The moment its marginal revenue is dropping below the average variable cost, it can stop producing further.

In the long run, as the competitors see that the firms are generating economic profit in the perfectly competitive market, they start entering the market. As a result, the supply of the product increases leading to a fall in the price and thus the economic profit falls. If this continues, a point reaches where the economic profit of the firm goes below zero and thus the firms need to shutdown the production.