Question

Suppose the demand for a monopoly’s product falls so that its profit-maximizing price is below average variable cost. How much output should the firm supply?

Short answer

The firm supply is if the price falls below AVC, the company will not be able to collect enough income to pay its variable expenses, much alone cover its fixed costs.

Step-by-step solution

Definition

Average variable cost:

The average variable cost per unit of production is the total variable cost per unit of production (AVC). This is the outcome of total variable cost (TVC) divided by total production (Q). Total variable cost refers to all costs that change with output, such as materials and labor (TVC).

Explanation

If the price falls below AVC, the company will not be able to collect enough income to pay its variable expenses, much alone cover its fixed costs. It will suffer a smaller loss if it shuts down and generates no output in this instance. If it stayed in business and produced at the level where MR = MC, however, it would lose all of its fixed costs as well as some variable costs. It only loses its fixed costs if it shuts down.