Submitted by: Submitted by kayiboyu
Views: 231
Words: 1481
Pages: 6
Category: Business and Industry
Date Submitted: 12/16/2012 01:33 AM
1. Why would a firm that incurs losses choose to produce rather than shut down?
Losses occur when revenues do not cover total costs. Revenues could be greater than variable costs, but not total costs, in which case the firm is better off producing in the short run rather than shutting down, even though they are incurring a loss. The firm should compare the level of loss with no production to the level of loss with positive production, and pick the option which results in the smallest loss. In the short run, losses will be minimized as long as the firm covers its variable costs. In the long run, all costs are variable, and thus, all costs must be covered if the firm is to remain in business.
2. The supply curve for a firm in the short run is the short-run marginal cost curve (above the point of minimum average variable cost). Why is the supply curve in the long run not the long-run marginal cost curve (above the point of minimum average total cost)?
In the short run, a change in the market price induces the profit-maximizing firm to change its optimal level of output. This optimal output occurs when price is equal to marginal cost, as long as marginal cost exceeds average variable cost. Therefore, the supply curve of the firm is its marginal cost curve, above average variable cost. (When the price falls below average variable cost, the firm will shut down.)
In the long run, the firm adjusts its inputs so that its long-run marginal cost is equal to the market price. At this level of output, it is operating on a short-run marginal cost curve where short-run marginal cost is equal to price. As the long-run price changes, the firm gradually changes its mix of inputs to minimize cost. Thus, the long-run supply response is this adjustment from one set of short-run marginal cost curves to another.
Note also that in the long run there will be entry and the firm will earn zero profit, so that any level of output where MC>AC is not possible.
3. In long-run...