A Perfect Competitor's Choice- either 'Limp Along' or 'Shut Down' (an analysis of fixed and variable costs): Please note that we previously learned that Average Total Cost (ATC) is calculated by adding Average Variable Cost (AVC) and Average Fixed Cost (AFC). AVC and AFC are very different as it relates to production. Remember that AVC is tied to production. You only incur AVC when you produce. Average Fixed Costs operate much differently. These costs are usually prepaid costs such as prepaid rent or prepaid insurance. TFC is not tied to production and occurs whether you are producing or not. Let's say that you want to start a business. You pay for the first six month's rent (fixed cost) and pay a person to make widgets (variable cost). At the end of three months you decide to end your business endeavor. Your variable costs end when you discharge your worker, but your fixed costs continue because you have prepaid for six month's rent. Even though you are no longer producing, you are incurring these fixed costs. Unprofitable businesses are up against the same problem when it comes to these two costs, and basically have two options: Option 1- Even though currently

unprofitable, decide to 'limp along' and quickly find ways to become profitable. This option is chosen when the price of a company's product covers all of its AVC (production costs) and at least part of its AFC. The reasoning here is that if it shuts down it will be responsible for 'all' of its AFC, but since the product price is paying some of the AFC it is better to continue and quickly find ways to become profitable. Let's say a

perfect competitor is changing $8 for their product, which covers it's AVC of $5, with $3 left over to cover some of its AFC which is $12, so the price the business charges covers $3.00 of its AFC. This company will 'limp along', and quickly find ways to once again more than cover all its costs (AVC and AFC) and achieve a profit.

Option 2- If, however a perfect competitor's price doesn't cover any of it AFC it will choose to 'shutdown', since it is responsible for all of its AFC anyway, even if it does not operate. Let's say another perfect competitor that is also not profitable is charging $5 for their product, which just covers its AVC of $5.00, with nothing left to cover any of the AFC of $10. This company will 'shut down' because its price is not covering any of its AFC, and since it is already responsible for this cost whether it is operating or not.

**Construct two scenarios, where a perfect competitor will 'limp along' and two scenarios where a perfect

competitor will 'shutdown', using your own values for price, AVC and AFC.

**Explain the relationship of Perfect Competition and Economic Efficiency.