Answer to Question #60457 in Microeconomics for Bob

Question

a) Graphically illustrate a perfectly competitive firm incurring a loss in the short run.
Explain what is meant by “shut-down determination” in the short run.

b) If perfectly competitive firms are incurring a loss in the short run, graphically illustrate and explain the adjustments to long-run equilibrium.

c) Graphically derive and explain the underlying theory of the long run industry supply curve, assuming a constant cost industry.

Answer 1

a) A perfectly competitive firm incurs a loss in the short run, if the market price is lower than its average total costs, but higher than its average variable costs (ATC > P > AVC).
The “shut-down point” in the short run is the point, where P = AVC. Below this point the firm can't cover even its variable costs and should shut down.
b) If perfectly competitive firms are incurring a loss in the short run, then some of the firms will exit the market, until in the long-run all the rest firms will receive only zero profits producing at the point at which P = ATC = LRATC (long-run ATC).
c) Long run industry supply curve is the part of marginal cost curve after the intersection with the AVC curve.