Question 7.2

1. Draw a short-run diagram showing a U-shaped average total cost curve, a U-shaped average variable cost curve, and a “swoosh”-shaped marginal cost curve. On it, indicate the range of output and the range of price for which the following actions are optimal.

  1. The firm shuts down immediately.

    The firm should shut down immediately when price is less than minimum average variable cost, the shut-down price. In the accompanying diagram, this is optimal for prices in the range 0 to P1.

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  2. The firm operates in the short run despite sustaining a loss.

    When price is greater than minimum average variable cost (the shut-down price) but less than minimum average total cost (the break-even price), the firm should continue to operate in the short run even though it is making a loss. This is optimal for prices in the range P1 to P2 and for quantities Q1 to Q2.

  3. The firm operates while making a profit.

    When price exceeds minimum average total cost (the break-even price), the firm makes a profit. This happens for prices in excess of P2 and results in quantities greater than Q2.