LOSS MINIMIZATION RULE:

A rule stating that a firm minimizes economic loss by producing output in the short run that equates marginal revenue and marginal cost if price is less than average total cost but greater than average variable cost. This is one of three short-run production alternatives facing a firm. The other two are profit maximization (if price exceeds average total cost) and shutdown (if price is less than average variable cost).

• With profit maximization, price exceeds average total cost at the quantity that equates marginal revenue and marginal cost. In this case, the firm generates an economic profit.


• With shutdown, price is less than average variable cost at the quantity that equates marginal revenue and marginal cost. In this case, the firm incurs a smaller loss by producing no output and incurring a loss equal to total fixed cost.

Incurring a Loss

• If price is greater than average variable cost, a firm receives sufficient revenue to pay ALL variable cost plus some fixed cost. As such, the economic loss is less than total fixed cost. A firm is better off producing the quantity that equates marginal revenue and marginal cost than producing no output, receiving no revenue, and incurring a loss equal to total fixed cost.


• If price is less than average variable cost, a firm does not receive enough revenue to pay variable cost let alone any part of fixed cost. As such, the economic loss of operating is greater than total fixed cost. A firm is better off shutting down production in the short run, producing zero output, and awaiting a higher price.