Assume a perfectly competitive firm is currently producing 5,000 units

Assume a perfectly competitive firm is currently producing 5,000 units of output and is earning $15,000 in total revenue. The marginal cost of the 5,000th unit of output is $3. The corresponding average total cost is $3.

50 and total fixed costs equal $1250. Based on this information, should this firm continue to operate in the short run? Why or why not?

ANSWER

No, the firm should not continue to operate and should instead shut down. Based on the information in the question, market price (and marginal revenue) equals $3 ($15,000/5,000). In addition, average fixed cost equals $0.25 ($1250/5000). As such the firm’s average variable cost, which is equal to the difference between average total cost and average fixed cost, equals $3.25. Because price is less than AVC at the profit-maximizing (in this case loss-minimizing) level of output, the firm will minimize its losses by shutting down.