Learning Path
Question & Answer1
Understand Question2
Review Options3
Learn Explanation4
Explore TopicChoose the Best Answer
A
The firm continues production if the market price is above average variable costs, despite losses.
B
The firm will stop production immediately to avoid further losses, regardless of average variable costs.
C
The firm will continue to produce even if the price is below average variable costs, anticipating future profits.
D
The firm can only sustain production if it covers both fixed and variable costs.
Understanding the Answer
Let's break down why this is correct
Answer
In a perfectly competitive market, firms are price takers, meaning they cannot set their own prices and must accept the market price. If consumer income decreases and market prices drop, the firm's revenue will also decline. In the short run, the firm will compare its costs to the market price; if the price is above its average variable cost, it will continue to produce to cover some of its fixed costs. For example, if a bakery's costs to make bread are $2 per loaf but the market price drops to $3, it will keep producing because it can still make a profit. However, if the price falls below its costs, the firm may decide to reduce production or temporarily shut down until conditions improve.
Detailed Explanation
The firm will keep producing if the price is higher than its average variable costs. Other options are incorrect because Some might think stopping production is always best to avoid losses; This option suggests producing when prices are too low, expecting future profits.
Key Concepts
Short-Run Production Decisions
Average Variable Cost
Perfect Competition
Topic
Short-Run Production Decisions
Difficulty
medium level question
Cognitive Level
understand
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