“Even if a firm is losing money, it may be better to stay in business in the short run.”
“Even if a firm is losing money, it may be better to stay in business in the short run.” Is this statement ever true? If so, under what condition(s)?
A firm has fixed costs and variable costs. Assuming that a firm has a fixed cost of $1000, it has to pay the fixed cost irrespective of how much goods it produces. Let the average variable cost be dollar 10 and the price of the good be $15. If the firm produces output at an optimal level of 100 units and marginal revenue is equal to marginal cost, then the total revenue that the firm produces is $1500, and the total cost is $2000 as variable cost is $1000. So loss inquired by the firm is $500 which is less than the loss the firm would have inquired if it did not produce at all. Therefore, it should keep on producing as long as the price is more than the average variable cost rather than shutting the business down.
A firm should produce because it has to incur fixed costs even if it is not producing any output. Therefore, in the short run, a firm should keep on producing if the price is greater than average variable costs as the price might cover some of the fixed costs. Thus, the loss of not producing anything at all is the fixed cost. However, if it produces something, the loss can be reduced.
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