The average cost of production at the profit maximizing output level for Jones Inc., is $4 per unit.The average variable cost of production is $3.5 per unit at this output level.The introduction of cheaper substitutes reduces the demand drastically and the market price falls to $1.5 per unit.If the minimum average variable cost the firm must incur is $2.5, identify the correct statement from the following.
A)There are output levels where revenue exceeds variable cost when the price is $1.5 per unit.
B)The firm will continue to operate in the short run.
C)The firm will breakeven at the price of $1.5 per unit.
D)The firm will shut down.

Question

Quizplus · Accepted Answer

At a market price of $1.5 per unit, the firm's revenue would be less than the minimum average variable cost of production ($2.5), meaning the firm would incur a loss on every unit produced. Therefore, the firm would shut down in the short run. Option A is incorrect because when the firm is incurring a loss, revenue cannot exceed variable cost. Option B is incorrect because the firm is not able to cover its variable costs, let alone generate any profit. Option C is incorrect because the minimum average variable cost is $2.5, and the market price is only $1.5, so the firm cannot even breakeven.

The Average Cost of Production at the Profit Maximizing Output