# Why do some perfectly competitive, loss-making firms shutdown and others don't?

## Question:

Why do perfectly competitive, loss-making firms that have (AC>AVC>AR) shutdown but

Firms that have (AC>AR>AVC) not shutdown?

-Both of these types of firms are making a loss. How is it significant that the latter type's AVC is less than AR ? How does that affect whether it shuts down ?**

These two graphs are for the two types of firms in perfectly competitive markets:

• Loss-making firms where their AC > AR & AVC > AR that shutdown
• Loss-making firms where their AC > AR & AVC < AR that don't shutdown.
• Your inequalities need to be fixed, I think for the firms that shut down AC>AVC>AR, and for the firms that don't shut down AC>AR>AVC. Can you please fix it for future clarity. Your graphs are fine. – Regio Apr 22 at 3:30

## 1 Answer

$$AVC means, without considering fixed cost, the firm is making a profit of $$AR-AVC>0$$ per unit of output. Compare the two options: keep producing vs shutdown:

• Keep producing: $$\text{Avg Profit}=\underbrace{AR-AVC}_{>0}-AFC$$
• Shutdown: $$\text{Avg Profit}=0-AFC$$

Since $$AVC, staying in production is better since the revenues can be used to offset part of the fixed costs already incurred.

$$AVC>AR$$ means, without considering fixed costs, the firm is making a loss of $$AR-AVC<0$$ per unit of output. Compare the two options: keep producing vs shutdown:

• Keep producing: $$\text{Avg Profit}=\underbrace{AR-AVC}_{<0}-AFC$$
• Shutdown: $$\text{Avg Profit}=0-AFC$$

Since $$AVC>AR$$, shutting down leads to a smaller loss than staying in production.