Theme 3 - market structures

Question 1

what is the shutdown condition, when should firms consider shutting down and way? - perfect competition

Answer 1

when AR = AVC,
- When AR = AVC, the firm is just covering its variable costs, meaning it can’t contribute anything to covering fixed costs, such as rent or machinery expenses.

• the firm earns zero economic profit,

Question 2

what is the breakeven condition - perfect competition

Answer 2

when AR = AC (normal profit)
- When AC = AR, the firm is covering all its costs (both fixed and variable) and earning zero economic profit. This means it’s not making a loss, so there is no immediate reason to shut down.
- If market conditions improve (e.g., an increase in demand), the firm could start earning positive profits.

Question 3

when should firms completely shut down - perfect competition

Answer 3

when AR < AVC
- If AR < AVC, the firm is not even covering its variable costs, meaning it’s losing money on every unit produced.
- Staying open with AR < AVC leads to a negative cash flow, making it unsustainable in the short run as the firm cannot pay for essential inputs like labor and materials.
- By shutting down, the firm avoids additional variable costs, which helps minimize losses to just fixed costs. Continuing production would increase its losses further.