Question

Mrs. Smith operates a business in a competitive market.  The current market price is $8.10.  At her profit-maximizing level of production, the average variable cost is $8.00, and the average total cost is $8.25.  Mrs. Smith should:                             

a. shut down her business in the short run but continue to operate in the long run.

b. continue to operate in the short run but shut down in the long run.

c. continue to operate in both the short run and long run.

d. shut down in both the short run and long run.

Answer 1

The market price is \(\$ 8.10 .\) At the profit-maximizing level of production, the average variable cost is \(\$ 8\), and the average total cost is \(\$ 8.25\).

In the short run, an entrepreneur only aims at covering the cost of its variable inputs and is ready to bear the cost of its fixed assets. Since the market price is more than the average variable cost, this firm will operate in the short run.

In the long run, however, the firm aims at covering both the costs of its fixed as well as the variable inputs. Since the total cost is less than the market price, this firm will shut down in the long run.

Therefore, the correct answer is option b. continue to operate in the short run but shut down in the long run.