If a firm has short-run losses, will it stay open? Under what conditions will a firm close in the short run? Explain.
What will be an ideal response?
The firm suffers losses if P < AC so that revenue does not cover costs. The firm will stay open if P > minimum of AVC. If the firm shuts down, revenue falls to zero but fixed costs continue as obligations of the firm. Therefore, if P > minimum of AVC, the firm can cover its variable (avoidable) obligations and a portion of fixed (unavoidable) obligations. Such a decision cuts losses, so that it is more profitable to produce than to close. However, if P < minimum of AVC, the firm should close. Revenue is insufficient to cover variable (avoidable) costs, much less cover some portion of fixed (unavoidable) costs. Loss minimization in this case requires closing down.
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