Firms enter the business to earn a profit. However, the amount of profit earned by the firm will not be the same at all levels of production. So naturally, every firm chooses that level of output which ensures maximum profit. In case the market condition is such that loss is unavoidable, the firm adjusts its output to reduce the loss to the minimum.
A firm in the short run earns an abnormal profit when at the equilibrium level of output, the market price is greater than the average cost or (AR > AC).
The firm is in equilibrium at point L where SMR=SMC and marginal cost is rising. The firm will produce ON quantity of output and sell at market pries OP. The total revenue of the firm is equal to OPLN. Whereas the total cost of producing ON quantity of output is equal to OKMN. The firm is earning profits equal to the shaded area KPLM. The per unit profit is indicated by the distance LM or PK.
Loss Minimizing Case
The firm is the short run is minimizing losses if the market price is smaller than average total cost but larger than average variable cost or ARC < AC > AVC
The firm is in equilibrium at point N where MR=MC. The firm output level is OK which is sold at unit cost OP. The total revenue of the firm is equal to the area OPNK. The total cost of producing OK quantity of output is equal to OTSK. The firm suffering a net loss equal to the shaded area PTSN.
The firm at price OP, is covering its full variable cost and a part of fixed cost. The loss of part of fixed cost equal to the shaded area PTSN is less than the firm would incur by closing down. In case of shut down, the firm has to bear the total fixed cost ETSF. The firm thus by producing OK output and selling at OP price is minimizing losses.
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Naeem Javid Muhammad Hassani is working as Conservator of Forests in Balochistan Forest & Wildlife Department (BFWD). He is the CEO of Tech Urdu (techurdu.net) Forestrypedia (forestrypedia.com), All Pak Notifications (allpaknotifications.com), Essayspedia, etc & their YouTube Channels). He is an Environmentalist, Blogger, YouTuber, Developer & Vlogger.
