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Question
Explain the short-run equilibrium of a firm facing losses under Perfect Competition.
Solution
When a company suffers losses, it may be claimed that the company should not close down. Even if the company closes down in the near run, it cannot change its capital equipment and must consequently face a loss equal to the fixed cost. As a result, if the firm can make income that exceeds its variable costs, it may be able to meet its variable costs while also covering a portion of its fixed costs.
- When a company's average revenue is less than its average expense, it is considered to be losing money.
- The average cost is CQ, and the average revenue is DQ in the following figure at the current price of P2.
- Because the average cost exceeds the average revenue, the firm is said to be losing CD per unit of output. Furthermore, the overall loss on the OQ level of output equals the shaded area P1, P2, CD.
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