A firm’s reasoning in the long run, when the market price is below its LRAC at every output, is given below with one step missing:
Step 1: At any positive output, TR = p × q is less than TC = LRAC × q.
Step 2: So, at any positive output, the firm makes a loss.
Step 3: ________
Step 4: So, the firm exits the market.
Which of the following is the missing Step 3?
Answer & explanation
Correct answer: option 1
The correct answer is Option (1) → If it shuts down in the long run, its profit is zero.
The firm compares the loss from producing with its profit from shutting down. In the long run, shutting down gives zero profit, which is better than a loss, so the firm exits.
Option (1) If it shuts down in the long run, its profit is zero. — Correct. In the long run there is no fixed cost, so zero output means zero profit. Zero is more than a loss, which leads to Step 4.
Option (2) If it shuts down in the long run, its profit is −TFC. — Incorrect. A profit of −TFC at zero output belongs to the short run, when fixed costs must still be paid.
Option (3) If it shuts down, the market price becomes greater than its LRAC. — Incorrect. A single firm is a price-taker. Its shutting down does not change the market price.
Option (4) If it shuts down in the long run, its loss is the same as the loss it makes by producing. — Incorrect. With no output there is no revenue and, in the long run, no cost either. So shutting down removes the loss.
NCERT (2026-27): “Case 2: Price must be greater than or equal to AC in the long run … Notice that the firm’s total revenue, TR, at q1 is the area of the rectangle OpAq1 (the product of price and quantity) while the firm’s total cost, TC , is the area of the rectangle OEBq1 (the product of average cost and quantity). Since the area of rectangle OEBq1 is larger than the area of rectangle OpAq1, the firm incurs a loss at the output level q1. But, in the long run set-up, a firm that shuts down production has a profit of zero. Again, the firm chooses to exit in this case.” |