Assume, in an industry where there are no barriers to entry and firms are making an economic loss in the short run.
a) What options are available to firms in the short run to minimise their losses?
b) Using demand and supply analysis together with the cost curves, explain why the actions to minimise loss lead to firms’ making normal profit in the long run? 3 + 3 = 6 Marks
If there are no barriers to entry and firms are making an economic loss in the short run, then: a) in the short run firms can only continue to produce the amount of output, at which MR = MC to minimise their losses, if ATC > P > AVC, but if P < AVC, then the firm should shut down.
b) after some firms exit the market, the price level will increase according to the leftward shift of the supply curve, so this will lead to firms’ making normal profit in the long run.