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CA Foundation · Business Economics · Price Determination in Different Markets

In the short run, a perfectly competitive firm is producing the output at which MC equals market price. At this output, the price is less than average total cost but greater than average variable cost. What should the firm do?

The firm should continue producing in the short run. Price exceeds average variable cost, so revenue covers all variable costs and contributes towards fixed costs. Shutting down would mean losing the entire fixed cost, which is a bigger loss. A price taker also cannot raise its price.

  1. AShut down immediately, since it is making a loss
  2. BContinue producing, because it recovers all variable cost and part of fixed costCorrect
  3. CRaise its price above the market price to cover average total cost
  4. DExpand output until average total cost falls to equal marginal cost

Explanation

When P is below ATC but above AVC, the firm makes a loss, but each unit's revenue covers variable cost and leaves a contribution toward fixed cost. Shutting down would lose the whole fixed cost, so the firm continues. Raising price is impossible for a price taker, so that option is wrong.

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