Question

Your company identifies the amount of output where marginal revenue equals marginal cost; at this amount of output, the price is below average total cost but above average variable cost. Your company should expect

Select one:

a. to break even or earn a normal profit.

b. to earn above-normal economic profit.

c. to take losses, but should continue in operation in order to avoid a greater loss of fixed costs.

d. to take such large losses that it should cease operations for a while.

Answer 1

Answer - c. to take losses, but should continue in operation in order to avoid a greater loss of fixed costs.
The first order condition for equilibrium is MR=MC. As per the information given the question, the firm is in equilibrium as its MR=MC.

Further, it is mentioned that the price (AR) is below the average total cost. This implies that the firm is getting losses. (AR or Price < ATC)

However, it given that the AR or Price is above the Average Variable Cost (P>AVC). This indicates that though the firm is incurring losses, it is able to recover the variable cost and some part of the fixed cost too. Hence, it is expected that to take losses, but should continue in operation in order to avoid a greater loss of fixed costs.

In this condition if the firm shuts down the loss will be the total fixed cost and that would be a greater loss then the loss incurred by continuing the production. If the price falls below the AVC, then the firm shuts down.

In the given condition, the firm should take losses, but should continue in operation in order to avoid a greater loss of fixed costs.