Contradiction in principles of microeconomics textbooks regarding the shut-down decision of a perfectly competitive firm.

Abstract

Contradiction in principles of microeconomics textbooks regarding the shut-down decision of a perfectly competitive firm.

Luis Lepervanche, Undergraduate; Alyssa Howard, Undergraduate

The University of North Georgia, Mike Cottrell College of Business

There is a branch of microeconomics that studies markets in perfect competition. Firms in perfect competition have both fixed and variable costs associated with production. The average variable cost (AVC) is used in comparison to the market equilibrium price in order to determine whether firms in the market should shut down production. Most economic textbooks explain that when market equilibrium price falls below AVC, firms should shut down. However, this assumption is inherently incorrect because equilibrium price cannot fall below AVC. This study aims to prove that price is unable to fall below AVC and therefore describes a contradiction found in principles of microeconomics textbooks involving the model of perfect competition. In order to prove this, an explicative investigation was designed including a survey of eleven principles of microeconomics textbooks and a graphical explanation proving the hypothesis. Every textbook surveyed gave the possibility that market equilibrium price could fall below AVC and the graphical explanation constructed showed that market equilibrium price cannot fall below AVC in any situation. This investigation effectively determined that the standard textbooks surveyed all contained the incorrect assumption that price can fall below AVC.

Keywords: Average variable cost (AVC), market equilibrium price, shutdown, perfect competition, production