3. True or False? d. A firm that receives a price larger than its average variable costs but less than its average total cost in the short run should shut down.
In the short run, a firm may operate with excess profit, normal profit, and even incurring loss. But the firm will not operate under the shutdown condition.
Excess profit:
If the firm receives a price more than the short-run average total cost (SATC) which includes both average fixed cost and average variable cost, then the firm earns an excess profit. Excess profit is the profit earned by a firm over and above the normal profit and it may also be called supernormal profit.
Normal Profit:
If the firm receives a price equal to its short-run average total cost (SATC) that means a firm is covering its total cost and earns a normal profit. Normal profit is a condition where there is no profit and no loss.
Loss:
If the firm receives a price larger than its average variable cost (SAVC) but less than its average total cost (SATC), then the firm is incurring losses. The loss incurred is equal to a part of a fixed cost because it covers the entire variable cost and also a part of the fixed cost. A firm must cover its variable cost to remain and operates the firm in the market. Therefore, in this condition, the firm must continue its production and function since its total revenue (TR) is more than the total variable cost (TVC) which enables the firm to cover a part of the total fixed cost (TFC).
Shutdown:
If the firm receives a price less than both average total cost, and average variable cost, then the firm should shut down. Because the firm is not in the position to cover even the variable cost, therefore the best option in front of the firm is to close down, and wait for the price to rise or the cost to decline, so that it can cover at least the total variable cost (TVC) and possibly cover the total fixed cost (TFC) too.
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