In the context of a firm's shutdown decision, what distinguishes the short run from the long run?

• A. In the short run, a firm must shut down immediately if it does not cover total costs.
• B. In the short run, a firm can freely enter or exit the market without any restrictions.
• C. In the short run, a firm will continue operating as long as price covers average variable cost, even if it incurs losses.
• D. In the short run, all inputs are variable and there are no fixed costs.

Answer: (C)

Verified step by step guidance

1. Step 1: Understand the difference between the short run and the long run in microeconomics. The short run is a period during which at least one input (such as capital) is fixed, while in the long run, all inputs are variable and firms can enter or exit the market freely.
2. Step 2: Recognize that in the short run, firms face fixed costs that must be paid regardless of output, so the decision to shut down depends on whether the firm can cover its variable costs, not total costs.
3. Step 3: Recall the shutdown rule: a firm will continue operating in the short run if the market price (P) is greater than or equal to the average variable cost (AVC), even if it incurs losses because fixed costs are sunk in the short run.
4. Step 4: Contrast this with the long run, where firms will exit the market if they cannot cover total costs (both fixed and variable), since all costs are avoidable and firms can adjust all inputs or leave the industry.
5. Step 5: Summarize that the key distinction is that in the short run, the firm’s shutdown decision depends on covering AVC, while in the long run, it depends on covering total costs, reflecting the flexibility of input adjustment and market entry/exit.