How does the average variable cost curve help a firm know whether it should shut down immediately?

How does the average variable cost curve help a firm know whether it should shut down immediately?

• A. Shut down when price is below AVC
• B. Shut down when price equals ATC
• C. Shut down when price is above AVC
• D. Shut down when AVC is decreasing

Answer: (A)

The key idea is that, in the short run, a firm must cover its variable costs to stay afloat. The average variable cost (AVC) curve shows the per-unit variable cost at each output level, and the lowest point of that curve is the shutdown price. If the market price falls below that minimum, the firm cannot cover its variable costs no matter how much it produces, so producing would add losses beyond the fixed costs. Shutting down then minimizes losses to just the fixed costs. If the price is at or above the minimum AVC, the firm can cover its variable costs by producing, so it should continue operating (preserving the ability to contribute to fixed costs and potentially earn a profit if price is high enough).

The key idea is that, in the short run, a firm must cover its variable costs to stay afloat. The average variable cost (AVC) curve shows the per-unit variable cost at each output level, and the lowest point of that curve is the shutdown price. If the market price falls below that minimum, the firm cannot cover its variable costs no matter how much it produces, so producing would add losses beyond the fixed costs. Shutting down then minimizes losses to just the fixed costs. If the price is at or above the minimum AVC, the firm can cover its variable costs by producing, so it should continue operating (preserving the ability to contribute to fixed costs and potentially earn a profit if price is high enough).