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A profit-maximizing firm is producing where MR = MC and has an average total cost of $12, but it gets a price of $8 for each good it sells
A profit-maximizing firm is producing where MR = MC and has an average total cost of $12, but it gets a price of $8 for each good it sells. What would you advise the firm to do if you knew average variable costs were $9?
A. The firm should shut down in the short run and exit the market in the long run.
B. The firm should exit the market in the long run, but it should produce in the short run since it is covering average fixed costs.
C. The firm should shut down in the short run. Once the firm recoups its fixed costs, it should reopen in the long run.
D. The firm is producing where MR = MC, so it should produce in both the short run and long run.
Expert Solution
The correct answer is: A. The firm should shut down in the short run and exit the market in the long run.
In the short run, the firm should continue operating in the market if it is able to make enough revenue to cater to its variable cost. Therefore, the firm should continue operating if the market price is greater than the average variable cost.
The price charged by the firm described above is P = $8 and its average variable cost is AVC = $9. Since P<AVCP<AVC for this firm, the firm should temporarily shut down in the short run.
In the long run, the firm should continue operating if is making enough revenues to cater to its total cost. Otherwise, the firm should exit the market. Therefore, a firm should continue operating in the long run if the market price is greater than the average total cost.
The average total cost for this firm is ATC = $12 and the price it charges is equal to P = $8. The firm should therefore exit the market in the long run since the prie it charges is less than its average total cost.
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