If a firm is incurring losses it must determine whether it should shut down immediately or continue producing with losses. In the long run if losses continue the firm should always shut down, but in the short run this may not be the case.
Consider the firm depicted to the right. It is producing the
profit maximizing output but it is operating at a loss since P* < ATC. In the short run will its losses be greater if it shuts down or if it continues to produce Q*, which it sells at P*?
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