Assertion: In the long run, a firm does not produce if it earns anything less than the normal profit.
Reasoning: In the short run, a firm may produce even if the profit is less than the normal profit.
Answer & explanation
Correct answer: option 2
The correct answer is option 2: Both Assertion (A) and reasoning (R) are correct and but R is not the correct explanation of A.
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Assertion (A) is true:
- In the long run, a firm must earn at least normal profit (where Total Revenue = Total Cost, including opportunity costs) to remain in business.
- If it earns less than normal profit, it will exit the market because it cannot cover its total costs, including the return required to keep resources in the industry.
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Reasoning (R) is also true, but it does not explain A:
- In the short run, firms may continue operating even if they earn less than normal profit, as long as Price (P) ≥ AVC (Average Variable Cost).
- This is because, in the short run, fixed costs are already incurred (sunk costs), so the firm may still operate to minimize losses.
- However, this does not directly explain why a firm must shut down in the long run if it earns less than normal profit.
- The reasoning focuses on short-run behavior, whereas the assertion is about long-run firm decisions.
- Short-run survival does not explain long-run exit; in the long run, firms leave when they fail to cover total costs, including normal profit, which is not directly addressed in R.