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CA Foundation · Business Economics · Price Determination in Different Markets

A perfectly competitive firm produces 200 units at a market price of ₹25. Its average variable cost is ₹20 and average total cost is ₹28 at this output. What should the firm do in the short run?

The firm should continue producing in the short run. Price of ₹25 exceeds average variable cost of ₹20, so revenue covers all variable costs and contributes ₹5 per unit to fixed costs. Shutting down would lose the entire fixed cost, which is a larger loss.

  1. AShut down immediately, because it makes a loss
  2. BContinue producing, because price covers average variable costCorrect
  3. CRaise its price to ₹28 to cover average total cost
  4. DProduce more units until average fixed cost is zero

Explanation

Price ₹25 exceeds AVC ₹20, so each unit contributes ₹5 towards fixed costs. Total loss is (28-25)×200 = ₹600, but shutting down would lose all fixed costs of (28-20)×200 = ₹1,600. Hence continuing minimises loss. Raising price is impossible for a price taker.

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