Knowledge Builders

should a firm shut down immediately if it is making losses

by Rocky Osinski Published 1 year ago Updated 1 month ago
image

Should a firm shut down immediately if it is making losses? No. The firm should shut down only if its revenues are not able to cover its variable costs. If it is able to cover its variable costs, and perhaps some of its fixed costs, it should stay open in the short run.

As a rule of thumb, a decision to shut down in the long run – i.e., exiting the industry – should only be undertaken if revenues are unable to cover total costs. It means in the long run, a firm making losses should shut down permanently and exit the industry.Feb 18, 2022

Full Answer

Should a firm shut down if its revenues are low?

The firm should shut down only if its revenues are not able to cover its variable costs. If it is able to cover its variable costs, and perhaps some of its fixed costs, it should stay open in the short run. As long as price is above average variable costs, the firm should stay in business to minimize its losses in the short run.

When should a firm stay open in the short run?

If it is able to cover its variable costs, and perhaps some of its fixed costs, it should stay open in the short run. How does the average variable cost curve help a firm know whether it should shut down immediately?

Should a firm stay in business if the average variable costs?

As long as price is above average variable costs, the firm should stay in business to minimize its losses in the short run. How does the average variable cost curve help a firm know whether it should shut down immediately?

When does a profit-maximizing firm not choose to produce?

The firm would then increase production up to the point where the new price equals marginal cost, at a quantity of 90. Explain in words why a profit-maximizing firm will not choose to produce at a quantity where marginal cost exceeds marginal revenue.

image

At what point should a firm shut down?

For a one-product firm, the shutdown point occurs whenever the marginal revenue drops below marginal variable costs. For a multi-product firm, shutdown occurs when average marginal revenue drops below average variable costs.

When should a firm decide to shut down production?

A firm will choose to implement a shutdown of production when the revenue received from the sale of the goods or services produced cannot even cover the variable costs of production. In that situation, the firm will experience a higher loss when it produces, compared to not producing at all.

When should a competitive firm shut down?

If the market price that a perfectly competitive firm faces is below average variable cost at the profit-maximizing quantity of output, then the firm should shut down operations immediately.

Why a loss making firm in perfect competition would shut down in the long run?

In a perfectly competitive market in long-run equilibrium, an increase in demand creates economic profit in the short run and induces entry in the long run; a reduction in demand creates economic losses (negative economic profits) in the short run and forces some firms to exit the industry in the long run.

Why do firms continue to operate when they are making losses?

Firms will not immediately stop production if the firm becomes unprofitable. As long as the loss is less by operating than by stopping production the firm will continue to produce even though it is incurring a loss; that is, total revenue is greater than total variable cost, but total revenue is less than total cost.

Why would a firm that incurs losses choose to produce rather than shut down?

Why would a firm that incurs losses choose to produce rather than shut down? Losses occur when revenues do not cover total costs. If revenues are greater than variable costs, but not total costs, the firm is better off producing in the short run rather than shutting down, even though it is incurring a loss.

What is the shutdown condition for a firm in perfect competition?

A business needs to make at least normal profit in the long run to justify remaining in an industry but in the short run a firm will produce as long as price per unit > or equal to average variable cost (AR = AVC). This is called the shutdown price in a competitive market.

Under what condition will a firm shutdown temporarily explain?

A firm will shut down temporarily if the revenue it would get from producing is less than the variable costs of production. This occurs if price is less than average variable cost.

What are the necessary conditions for a company to shut down under perfect competition?

In a perfectly competitive market, firms continue to operate as long as the average variable cost is being recovered at the given market price i.e. shut down point is that point at which the market price falls to a level equal to the minimum of average variable cost.

When should a firm exit in the long run?

In the long run, when the firm can recover both fixed and variable costs, it will choose to exit if the price is less than average total cost. In a market with free entry and exit, profits are driven to zero in the long run and all firms produce at the efficient scale.

Which of the following correctly explains when a firm will choose to shut down?

A firm will shut down in the short run when price is less than average variable cost. Following this rule will limit losses to fixed costs. A competitive market where firms currently earn positive economic profit will see firms exit the industry from increased competition. Correct.

Should the firm instead shut down in the short run in the short run the firm should?

Characterize the firm's profit. Should the firm instead shut down in the short​ run? In the short​ run, the firm should continue to produce because price is greater than average variable cost.

When should a firm shut down in the long run?

As a rule of thumb, a decision to shut down in the long run – i.e., exiting the industry – should only be undertaken if revenues are unable to cover total costs. It means in the long run, a firm making losses should shut down permanently and exit the industry.

Why would a business shut down?

Common reasons cited for business failure include poor location, lack of experience, poor management, insufficient capital, unexpected growth, personal use of funds, over investing in fixed assets and poor credit arrangements. Yet, not all businesses close due to business failure.

At which point will a firm be indifferent whether to shut down or continue to produce?

A firm's shut down point is the price and quantity at which it is indifferent between producing and shutting down. The shutdown point occurs at the price and quantity at which average variable cost is a minimum. At the shutdown point, the firm is minimizing its loss and its loss equals total fixed costs.

What are the factors to be considered before making a shutdown decision?

The following factors must be taken into account when considering shutdown problems....Qualitative factorsStrategic fit. ... Customer relations. ... Supplier relations. ... Employee relations. ... Loss leader. ... Timing of shutdown.

What happens if a firm tries to increase prices?

If a perfectly competitive firm tries to increase prices, all of its customers will simply switch to another seller.

What is a firm in economics?

Firm is one that cannot influence the price in the market, but must accept it as a given.

Why is the marginal revenue curve flat?

The marginal revenue curve is flat for a perfectly competitive firm, because it cannot influence prices by changing the level of output.

What happens if the average cost curve is below the marginal revenue curve?

If the average cost curve is below the marginal revenue curve, or the price, at the selected level of output, the firm will make profits.

How is output determined?

Output is determined at the point where price equals marginal cost, and the price is set by the marketplace since the firm is a price taker.

What does "small" mean in a business?

Small in this instance, means that the firm has no ability to influence the price of its product, and must take the market price given.

Do firms lose money in the long run?

not continually lose money. In the long run, firms making losses are able to escape from their fixed costs, and their exit from the market will. push the price back up to the zero-profit level. In the long run, this process of entry and exit will drive the price in perfectly competitive markets to the.

What are the assumptions of a perfectly competitive firm?

: The four basic assumptions are: the product is homogeneous (same or identical products), there are many buyers and sellers, consumers have perfect information, and there are no barriers to entry or exit (easy entry and exit).

How are profits maximized?

Profits are maximized by producing up to the point at which marginal revenue is equal to marginal cost.

Why do firms charge a price equal to the minimum of its average cost of production?

It will charge a price equal to the minimum of its average cost of production, because perfect competition drives the price down to the zero profit level. (If price is above average costs then economic profits are being made. The economic profits will attract more firms in to this easy to get in to industry. More firms will shift the market supply curve to the right, which will drive down the market price. The market price will continue to fall until it is just equal to the minimum of the average total cost curve.) At this point, economic profits are zero, which means that firms in this industry are making a normal rate of return; a return comparable to similar industries.

How many units of revenue are profit maximizing?

As long as you add more in revenue than you add in cost you will increase profits by increasing production. This will be true up to the quantity of 90 units, where marginal revenue equals marginal cost. Thus, profits are maximized at a quantity of 90 units. 90 units is said to be the profit maximizing level of output.

What happens if marginal costs exceed marginal revenue?

Solution: If marginal costs exceed marginal revenue, then the firm will reduce its profits for every additional unit of output it produces— the last unit produced added more in costs than it added in revenue. Profit would be increased if production is decreased. Profit would be greatest at the production level where MR = MC.

What is a firm in a perfectly competitive market?

A firm in a perfectly competitive market is a price taker —the price is determined by the market and the individual firm has no control over the price.

Why is the market so competitive?

This is due to the low costs being passed on to consumers in the form of low prices.

What happens to a firm's revenue if it shuts down?from quizlet.com

If it continues to produce, however, and revenue is greater than variable costs, the firm can pay for some of its fixed cost, so its loss is less than it would be if it shut down . In the long run, all costs are variable, and thus all costs must be covered if the firm is to remain in business.

Why do firms lose money?from quizlet.com

Losses occur when revenues do not cover total costs. If revenues are greater than variable costs, but not total costs , the firm is better off producing in the short run rather than shutting down, even though it is incurring a loss. The reason is that the firm will be stuck will all its fixed cost and have no revenue if it shuts down, so its loss will equal its fixed cost. If it continues to produce, however, and revenue is greater than variable costs, the firm can pay for some of its fixed cost, so its loss is less than it would be if it shut down. In the long run, all costs are variable, and thus all costs must be covered if the firm is to remain in business.

Why do some firms make more accounting profits than others?from quizlet.com

Some firms may earn greater accounting profits than others because, for example, they own a superior source of an important input, but their economic profits will be the same. To be more concrete, suppose one firm can mine a critical input for $2 per pound while all other firms in the industry have to pay.

Why do firms enter an industry?from quizlet.com

Firms enter an industry when they expect to earn economic profit, even if the profit will be short-lived. These short-run economic profits are enough to encourage entry because there is no cost to entering the industry, and some economic profit is better than none.

How does entry and exit affect supply and price?from quizlet.com

In the long run, entry or exit continues until price equals long-run average cost and firms earn zero economic profit. A certain brand of vacuum cleaners can be purchased from several local stores as well as from several catalogues or websites. a.

What happens when economic profit falls to zero?from quizlet.com

So even when economic profit falls to zero, the firm will be doing as well as it could in any other industry, and then the owner will be indifferent to staying in the industry or exiting. At the beginning of the twentieth century, there were many small American automobile manufacturers.

When do losses occur?from quizlet.com

Losses occur when revenues do not cover total costs. If revenues are greater than variable costs, but not total costs, the firm is better off producing in the short run rather than shutting down, even though it is incurring a loss.

image
A B C D E F G H I J K L M N O P Q R S T U V W X Y Z 1 2 3 4 5 6 7 8 9