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Suppose a perfectly competitive firm faces the following situation: P = $6, output = 2,000, ATC = $7, MC = $6, and AVC = $6.50. Which statement is an accurate description of the firm's situation?
A) The firm incurs losses, but is not minimizing its losses.
B) The firm incurs profits but is not maximizing its profits.
C) The firm incurs losses and is minimizing its losses.
D) The firm is maximizing profits.

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Answer:

The answer is A.

Explanation:

The most important variables in this question are:

Price(P) =$6

Average Total Cost(ATC)=$7

Average Variable Cost(AVC)=$6.5

The firm in this question is not covering both its AVC and ATC.

The firm is incurring losses since it is unable to match up its price with its AVC. AVC is higher than the price for the good. So the firm should exit in the short run.

Also, the price the firm is charging is also less than ATC. At this point, profit is zero and the firm is not minimizing its losses.

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