Profits for Competitive and Monopolistic Firm1

Profits for Competitive and Monopolistic Firm1 - variable...

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Profits for Competitive and Monopolistic Firms Profit If the firm is making profits, that is, if P is greater than the average cost, then all is well, they will continue producing and selling goods. If P is less than AC, however, the firm is losing money. P < AC : the firm is losing money How will the firm respond to this? Firms make decisions differently for the short run and the long run. In the short run, (in economic terms, the immediate future), it is not feasible to "close shop" immediately. There are leases to end, bills to pay, creditors to pay off, and other concerns to take care of first. In such a case, the firm can make two choices: either to continue producing and selling goods for the time being (in order to minimize losses), or to stop production altogether (to cut losses). How does a firm decide which path to take? This decision is based on the firm's
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Unformatted text preview: variable costs. If the price is still higher than the average variable cost, it will continue production, if the price is lower than the average variable cost, it will shut down. P &gt; AVC : continue production in the short run P &lt; AVC : stop production in the short run Why is this? Think about it this way: in the first case, the firm is losing money in the big picture. Each unit that they make incurs some variable cost, but because that cost is lower than the price, they keep producing, since they can still recoup some of their losses by continuing production. In the second case, each additional unit of goods incurs more costs than revenue, since the average variable costs are higher than the selling price of the goods. It doesn't make sense for the firm to keep producing, since it will only make their losses even greater....
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