A firm will shut down in the short run if ______.
Answer & explanation
Correct answer: option 1
The correct answer is Option (1) → Price < Average Variable Cost.
In the short run, a firm will continue to operate as long as it can cover its average variable cost (AVC), even if it is making losses overall.
If Price is less than AVC, the firm cannot cover even its variable costs, and continuing production would increase its losses. In this case, the firm is better off shutting down temporarily to minimize losses to just fixed costs.
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Price < Average Fixed Cost – Incorrect. Fixed costs are sunk in the short run; they are not relevant for shutdown decisions.
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Total Revenue > Total Cost – Incorrect. This would mean the firm is making a profit, so it would not shut down.
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Price = Average Cost – Incorrect. This means the firm is breaking even and has no economic profit, but there’s no reason to shut down.