Explain in your own words why in the short run a firm may continue to produce even at a loss provided the price is more than the average variable cost. Also, provide an example of when a firm might face this decision. (Hint: Think about how fixed and variable costs may affect shut-down decisions.)

If P > AVC, continue to produce

Explanation:

The decision rules for a firm to continue operation or shut down when it is currently operating at a loss can be given as follows:

Scenario 1: If P > AVC, continue to produce.

Scenario 2: If P < AVC, shut down.

Under scenario 1, it is advisable for the firm to continue operation. This is because, at a price (P) greater than an average variable cost (AVC), the firm will be able to fully cover the variable cost of production and it will also be able to cover a part of the fixed cost but not fully. Therefore, the firm will be minimizing loss by continuing operation.

Under scenario 2, it is advisable for the to shut down operation. This is because, at a price (P) lower than the average variable cost (AVC), the firm is unable to fully cover the variable cost of operation not talk of saving a part of the fixed. Therefore, the firm will be minimizing loss by shutting down operation.

Therefore, scenario 1 is an example of when a firm might face the decision to continue to produce even at a loss provided the price is more than the average variable cost.

This is possible when such company operates in an unstable economy

Explanation:

An unstable economy where inflation and deflation is always the case gives room for a company to keep producing after taking into cognizance the fact sometime inflation will automatically make up for the difference in price. As for the variable coat, this is mostly associated with the cost of raw materials for production. This of course is also where the cost that results in loss arises from. The fixed cost are inevitable expenses that contributes to the overall cost in production.