Under which condition would the firm be incurring a loss?
Answers
Firms’s cost would be a sum of variable and fixed cost as we are talking about short run. In long run all costs are variable. In this case, therefore
C = VC + F
where C is Total cost of production, VC is variable cost of production and F is fixed cost of production.
Firm’s revenue from selling q units of output would be p.q where p is the price of the commodity.
Now,
Profit from producing zero level of output would be -F which says that a firm has to incur fixed cost even if it doesn't produce anything.
Profit from producing q units of output would be p.q- VC(q) -F
Firm would be better of going off business when producing nothing gives better returns than producing some q units of output i.e.
-F > p.q - VC(q) - F
=> VC(q) > p.q
=> VC(q)/q > p
i.e. AVC > p
This says that if average variable costs is greater than price of the good than the firm is better off going out of business since firm is not able to cover its variable costs too.
However, if the firm's average variable costs are less than its price (=MR) at the profit maximizing level of output, the firm will not shut down in the short run. The firm is better off continuing its operations because it can cover its variable costs and use any remaining revenues to pay off some of its fixed costs. The fact that the firm can pay its variable costs is all that matters because in the short‐run, the firm's fixed costs are sunk; the firm must pay its fixed costs regardless of whether or not it decides to shut down.
Answer:
Firm would be better of going off business when producing nothing gives better returns than producing some q units of output i.e. This says that if average variable costs is greater than price of the good than the firm is better off going out of business since firm is not able to cover its variable costs too.