Suppose a profit-maximizing firm in a competitive market produces rubber bands. When the market price for rubber bands rises above the minimum of its average variable cost, but still lies below the minimum of average total cost, in the short run the firm will
A)experience losses but will continue to produce rubber bands.
B)shut down.
C)earn both economic and accounting profits.
D)raise the price of its product.

Question

Quizplus · Accepted Answer

When the market price for rubber bands rises above the minimum of its average variable cost, but still lies below the minimum of average total cost, the firm will experience losses since it is not covering all of its costs. However, in the short run, the firm will still continue to produce rubber bands as long as the price is covering at least its variable costs. This is because shutting down would result in even greater losses as the firm would still have to pay its fixed costs. Therefore, the best choice is A. The firm cannot earn economic or accounting profits in this situation as the price is still below the minimum of average total cost. The firm also cannot raise the price of its product as it is in a competitive market and must accept the market price.

Suppose a Profit-Maximizing Firm in a Competitive Market Produces Rubber