If a profit-maximizing firm finds that price exceeds average variable cost and marginal cost is greater than marginal revenue, what action should it take?

Question

Quizplus · Accepted Answer

If price exceeds average variable cost, the firm is covering its variable costs and some of its fixed costs, which means it is earning a positive contribution to fixed costs. However, if marginal cost is greater than marginal revenue, the firm is not maximizing its profit. In this scenario, the firm should reduce its output, but continue producing as long as price exceeds average variable cost in the short run. By reducing output, the firm can decrease its marginal cost and move closer to the profit-maximizing level of output. Shutting down would not be an optimal choice because the firm is earning enough to cover its variable costs and some fixed costs, and it would lose its positive contribution to fixed costs if it shuts down. Increasing output would also not be optimal because marginal cost is greater than marginal revenue, meaning the firm's profit would decrease with additional output.

If a Profit-Maximizing Firm Finds That Price Exceeds Average Variable