If a purely competitive firm is currently facing a situation where the price of its product is lower than the average variable cost, but it believes that the market demand for its product will increase soon, then
A) the firm will produce a low level of output in the short run and leave the industry in the long run.
B) the firm will shut down in the short run and leave the industry in the long run.
C) the firm will produce a low level of output in the short run but expand its plant in the long run as demand increases.
D) the firm will shut down in the short run, but stay in the industry in the long run if it expects the product price to rise high enough soon.

Question

Quizplus · Accepted Answer

If the price of the product is lower than the average variable cost, the firm will incur losses in the short run. Therefore, the firm will shut down in the short run if it cannot cover its variable costs. However, if the firm believes that the market demand for its product will increase soon and lead to a higher product price, it may stay in the industry in the long run. In the short run, the firm will still shut down, but it will re-enter the market when the price goes up to cover at least its average total cost. Therefore, the best choice is D.

If a Purely Competitive Firm Is Currently Facing a Situation