Firms and Decisions (1)

Question 1

Define the types of economic profits.

Answer 1

Supernormal profits where TR > TC / AR > AC
Normal profits where TR = TC / AR = AC
Subnormal profits where TR < TC / AR < AC

Question 2

Explain the profit-maximising objective of firms.

Answer 2

The profit-maximising objective of firms arises due to the self-interest of firms. By gaining higher profits, firms can invest in research and development to improve on their product innovation and are more able to survive in competitive environments and tide over periods of low demand.

Question 3

Define Marginal revenue.

Answer 3

Marginal revenue is the additional revenue that a firm makes from selling one more unit of output produced.

Question 4

Define Marginal costs.

Answer 4

Marginal cost is the additional cost that a firm incurs from increasing output produced by one unit.

Question 5

Explain how firms maximise their profits.

Answer 5

Firms make use of the marginalist principle and maximise profits where MR = MC. When MR > MC, the additional revenue to be obtained from selling an additional unit of output produced is greater than the additional cost of that output produced. There is still higher profit to be gained by increasing output. When MR < MC, the additional revenue to be obtained from selling an additional unit of output produced is less than the additional cost it would incur. The firm will cut back on its output to increase profits.

Question 6

Explain the limitations of the traditional theory of profit maximisation.

Answer 6

Most firms do not make a profit in the early stages of their existence hence profit maximisation is a relevant long-run objective that may not be possible in the short run.

When there are different groups of decision-makers with different objectives, Many firms may choose to sacrifice profits in the short term to increase profits in the long run and utilise other strategies to achieve profit maximisation in the long run. However, due to the principal-agent problem, firms may also have alternative objectives.

Firms may lack sufficient or accurate information about demand and cost conditions that exist and may not be able to use concepts of MC and MR when making price and output decisions. The cost of obtaining sufficient information to make such decisions may be very high especially for small firms.

It is difficult to decide the time period to maximise profits. Revenue and cost curves are not static due to evolving market conditions, changes in technology and government policies or the entrant of potential competitors.

Question 7

What are the three alternative objective of firms?

Answer 7

Revenue maximisation
Profit satisficing
Market share dominance

Question 8

Explain how the revenue maximisation objective of firms arises.

Answer 8

When a firm grows in size, there is a separation of ownership and control, resulting in the principal-agent problem where the objective of the shareholders (principal) which is profit maximisation differs from that of the managers, directors (agents). Shareholders tend to want strong returns and a rising share price but managers may wish to have power, bonuses and would maximise managerial utility in their self-interest. Often, the income of sales managers and commission-based employees are dependent on the firm’s revenue so a firm with a dominant sales department may choose to maximise revenue than profits.

Question 9

Explain how the profit satisficing objective of firms arises.

Answer 9

Instead of maximising profits, a firm may aim for minimum acceptable levels of revenue and profit. Compared to maximisers who try to make the best possible choice from available alternatives, satisficers examine only a limited set of alternatives and choose the best between them to avoid the expenditure of time, energy and resources to find the optimal cost and revenue conditions. When shareholders of a firm are removed from the operations of the firm to be fully aware of the optimal decision that needs to be made to maximise profits, managers can decide to achieve a given level of profits that are deemed to be acceptable by the shareholders even though it falls below the profit-maximising level and enjoys other benefits such as shorter working hours that maximise their managerial utility.

Question 10

Explain how the market dominance objective of firms arises.

Answer 10

Market share is measured by the proportion of the firm’s total sales over the total market sales.

Firms might wish to aim for market dominance as large firms attract better talent and gains and losses in market share may correlate with stock performance. Firms will try to influence demand/revenue by reducing prices, engaging in strategies to shift their demand curve outwards and making demand relatively less price elastic to enable them to raise prices and increase total revenue and profit, ceteris paribus, increasing their market share. Employees may prefer to work for bigger firms as it leads to greater prestige and higher salaries.

(Firms may also engage in entry deterrence - product differentiation through brand proliferation; develop new products, marketing/advertising to reinforce consumer loyalty. This causes new entrants to reconsider entry as it would also have to match the significant amount spent on advertising and promotion. Another method is through predatory pricing where the incumbent firm prices its goods below average variable cost of production so rival firms that cannot match the low prices will exist in the market, increasing the incumbent’s market share.)

Question 11

Define a firm.

Answer 11

Organisation formed by entrepreneurs who use FOP - land, capital and labour to produce goods or services for sale

Question 12

Define a market.

Answer 12

Exist whenever producers and consumers come together to transact with each other

Question 13

Define an industry.

Answer 13

Comprises of a group of firms that produce a single or related good or service

Question 14

Define economic cost.

Answer 14

Economic cost = Implicit cost + Explicit cost

The economic cost is the total opportunity cost of using scarce resources to produce one particular commodity in terms of the next best alternative foregone.

Question 15

Describe the shape of the short-run cost curves.

Answer 15

Pg 12 - 13 of notes.

Question 16

What are the types of scenarios that can occur when a firm increases its inputs (to scale refers to all FOP increasing by the same proportion)?

Answer 16

Constant returns to scale where the output increases proportionately to the increase in inputs

Decreasing returns to scale were the output increases less than proportionately to the increase in inputs

Increasing returns to scale where the output increases more than proportionately to the increase in inputs

Question 17

What costs are incurred in the long run?

Answer 17

Long-run costs are all variable costs as all factors of inputs can be varied.

Question 18

What costs are incurred in the short run?

Answer 18

Short-run costs include both fixed costs and variable costs as during which at least one factor of production is fixed and output can only increase by using more variable factors.

Question 19

Describe the LRAC.

Answer 19

The long-run average cost curve (LRAC curve) shows how average cost varies with output (Pg 15 of notes).

Question 20

State the internal factors that affect the shape of the LRAC curve.

Answer 20

Internal EOS

1) Technical EOS
2) Managerial EOS
3) Marketing EOS
4) Financial EOS
5) Risk-bearing EOS

Internal DisEOS

1) High costs of monitoring
2) Low morale of employees

Question 21

State the external factors that affect the shape of the LRAC curve.

Answer 21

External EOS

1) Economies of information
2) Economies of concentration
- Availability of skilled labour industry-specific
- Well developed infrastructure

External DisEOS

1) Increased strain on infrastructure
2) Shortage of industry-specific resources

Question 22

Explain what internal economies of scale and internal diseconomies of scale are and how they can be reflected on the LRAC curve.

Answer 22

Internal economies of scale are the cost savings that occur as a result of the firm’s expansion and have been created by the firm’s own policies and actions. It is represented by the falling part of the LRAC curve.

Internal diseconomies of scale are increases in costs (AC) that occur as a result of the firm’s expansion and have been created by the firm’s own policies and actions. It is represented by the upward sloping part of the LRAC curve and occurs beyond the minimum efficient scale (MES).

Question 23

Explain what external economies of scale and external diseconomies of scale are and how they can be reflected on the LRAC curve.

Answer 23

External economies of scale are defined as the savings in costs that occur to all firms as a result of the expansion of the industry and it is represented by a downward shift of the LRAC as average costs fall for each level of output.

External diseconomies of scale are defined as the increases in costs that occur to all firms in an industry as a result of the expansion of an industry and it is represented by an upward shift of the LRAC curve as average costs rise for each level of output.

Question 24

Explain technical EOS.

Answer 24

Technical EOS refer to gain in productivity or efficiency from scaling up production.

Factor indivisibility refers to inputs that are of a minimum size and cannot be divided into smaller units to suit smaller scales of production. Examples include database technology used by supermarkets to improve stock control and reduce distribution costs. Large firms can spread equipment cost over a larger output and have lower AC.

Specialization and division of labour refer to workers being assigned to do more specific and repetitive jobs in mass production at large scale plants. Less training is needed and workers being more efficient as less time is spent switching from one operation to another. This results in increased productivity and higher output per worker, lowering the unit cost of production for the firm. (Small firms have less room for specialisation)

Law of increased dimensions refers to the cubic law. Increasing the height and width of the container results in a more than proportionate increase in its capacity, meaning the average cost of containing and transporting goods will fall as scale increases and large firms can thus enjoy lower unit costs of production.

Question 25

Explain managerial EOS.

Answer 25

(Managerial EOS are related to specialisation and division of labour)

Managerial EOS refer to the specialisation that occurs on a supervisory level and increases productivity by employing specialists (HR, training managers) to better manage and supervise production systems. This can be complement with the use of specialist equipment such as networked computers that can improve communication, productivity and reduce unit costs. HR specialists do so by creating efficient and cost-effective hiring and labour search processes.

Question 26

Explain marketing EOS.

Answer 26

Marketing EOS refer to large scale buying which give large firms a bargaining advantage. They are accorded preferential treatment by suppliers because they buy raw materials in bulk, allowing them to dictate their requirements (price, quality, delivery etc) and pay lower prices. The bulk advertising and promotion allow firms to spread costs over a larger volume of sales, lowering unit costs.

Question 27

Explain financial EOS.

Answer 27

Financial EOS refer to large firms’ ability to raise funds for expansion. Large firms are often being given lower interest rates and larger loans because of better credit rating and greater collateral. The interest payments are also spread across a higher output, lowering AC.

Question 28

Explain risk-bearing EOS.

Answer 28

Risk-bearing EOS refer to the ability of firms to spread the uncertainty in the cost of production over a larger level of output and thereby reduce unit costs.

In the case of R&D in which the returns are highly variable and uncertain, firms can spread the risk of R&D costs by merging with other companies and spreading their expenditure over a larger volume of sales (discovering drugs - mergers between pharmaceutical companies).

These firms often produce a wide variety of products and operate in many geographical locations to spread risk and keep their average cost of production at competitive levels as they can mitigate rise in costs via cheaper costs of production in other locations and cushion demand shocks in poorer performing locations via better-performing ones.

They can also obtain raw materials from different sources to guard against events such as crop failures and strikes which will cause the cost of materials to spike.

Question 29

Explain the high cost of monitoring and management.

Answer 29

In large corporations with thousands of employees, the presence of a rigid organisation system with long chains of authorities leads to coordination and communication problems. This makes it difficult to maintain an effective flow of information between departments. Transportation and communication will incur costs that increase AC.

Due to the principal-agent problem where the objective of the shareholders (principal) which is profit maximisation differs from that of the managers, directors (agents) (i.e. shareholders tend to want strong returns and a rising share price but managers may wish to have power, bonuses and would maximise managerial utility in their self-interest), large firms will be less responsive to changing taste and preferences of consumers, changing market conditions compared to smaller, independent firms. Large firms may incur more costs to make the change faster.

Monitoring costs will increase when the firm needs to maintain quality and ensure standardisation across all outlets.

Question 30

Explain the low morale of employees.

Answer 30

Workers may develop a sense of alienation and loss of morale in overly large companies. Since the relationship between employees and management is important for maintaining productivity and efficiency, a long chain of authority in large firms will lead to impersonal relationships where workers do not consider themselves to be an integral part of the business. This wastage of factor inputs may cause productivity to fall, increasing the cost per unit output.

Question 31

Explain economies of information.

Answer 31

Economies of information refer to when firms in the industry share common R&D knowledge or facilities, allowing for increased information flows about R&D processes, cost-saving technologies that make production processes more efficient, sources of raw materials and new markets available. It also reduces unnecessary duplicates of R&D as firms can tap on the research of universities nearby that are likely to tailor their research toward the industry and provide scientific, trade journals that are published in the region.

Question 32

Explain economies of concentration.

Answer 32

Economies of concentration may result from the clustering of businesses in a distinct geographical location.

Availability of skilled labour industry-specific

Firms can join together to develop training facilities for their workers or special educational institutions when the demand for a particular type of skill is large enough. This will help firms in the industry to reduce the cost of training for their workers. The availability of skilled workers will also enable the firm to incur lower labour search costs, lowering AC.

Well developed infrastructure

The clustering of business may encourage governments to invest in infrastructure to cater to the industry, including better-connected roads to transport raw materials, public utilities and commercial facilities to support a larger workforce. This can improve productivity, increasing output per unit input and reduce AC for individual firms.

Examples include Singapore’s twin hubs of biomedical and engineering research - Biopolis and Fusionopolis

Question 33

Explain the increased strain on infrastructure.

Answer 33

Increased strain on infrastructure occurs when infrastructure is taxed to its limits due to the concentration of firms in a geographical region and the expansion of productive activities. E.g. traffic congestion increases AC due to loss of time and increased fuel consumption.

Question 34

Explain the shortage of industry-specific resources.

Answer 34

Shortage of industry-specific resources arises when an industry grows larger and it creates a growing shortage of specific raw materials and skilled labour. Competition for these resources will increase prices and the firm’s AC. e.g an increase in demand for engineers results in rising wages. The poaching of talented workers will result in higher turnover (the rate at which employees leave a workforce and are replaced) and labour search costs.

Question 35

State the curves required for each type of market structure. Explain why the AR curve of imperfect market structures is different from that of a perfect market structure.

Answer 35

PC Firm

• DD = AR = MR
• MC
• AC

Monopoly, Monopolistic, Oligopolistic

• DD = AR
• MR
• MC
• AC

In a perfect market structure, firms are price takers and have no incentive to increase or reduce prices hence demand is perfectly price elastic and the demand curve is a horizontal straight line which is also equal to the price of the good (determined by supply and demand of the market), average revenue and marginal revenue regardless of output level because the sale of each and every additional unit adds the exact same amount to the total revenue. However, in imperfect market structures, assuming the firm charges a uniform price for every unit of the good, it has to lower prices on all units to sell an additional unit. Thus, the MR curve will be negatively sloped and MR is always less than AR.

Question 36

Describe the long-run equilibrium of a monopoly.

Answer 36

A monopolist can retain supernormal profits by preventing new entrants by erecting significant BTEs. It will only remain in business if it can at least make normal profits and the long-run equilibrium of a profit-maximising monopoly is the output level where LRMC = MR and TR is at least equal to TC. The profits can be used to finance R&D to develop new products or improve on its production processes to lower costs (lowering LRAC curve) so as to further entrench its market power. Rival firms cannot match the monopolist’s low prices due to its EOS.

Question 37

Describe the adjustment to the long-run equilibrium of a monopolistic firm. Is a stable equilibrium ever reached?

Answer 37

Pg 51 and 52 of notes
Despite their price-setting ability, with very low barriers to entry, monopolistic firms can only make normal profits in the long run because potential entrants can easily enter and erode the supernormal profits existing firms make. The inability to return supernormal profits restricts the ability of firms to engage in large-scale advertising/R&D hence their products are only slightly differentiated. Such firms often engage in advertising and promotion on a relatively small scale.

When there are short-run supernormal profits to be made, new firms enter due to low BTE, increasing the number of close substitutes. The demand for each firm falls, AR shifts down until it is tangential to the AC curve. Demand becomes more price elastic and the AR curve is gentler. Long-run equilibrium: MC = MR and the firm’s profit maximising output price and quantity decreases and firms can only make normal profits where AC = AR.

On the other hand, when firms make short-run subnormal profits, firms that cannot cover their total variable cost - TR < TVC will shut down and leave the industry as the barriers to exit are low. Demand for the existing firm’s product will increase and becomes relatively less price elastic. The AR curve shifts to the right and becomes relatively steeper until it is tangential to AC where it makes normal profits. The resultant increase in price leads to a reduction in losses until the long-run equilibrium of normal profits is restored where LRMC cuts MR.

A stable equilibrium is never reached as new products come and go all the time and products goes through a product life cycle that affects the volume and growth of sales.

Question 38

Is there a difference in the demand curve of a monopolistically competitive firm and an oligopoly firm?

Answer 38

The oligopoly firm has a steeper demand curve than that of a monopolistically competitive firm.

Question 39

Is there a relationship between a firm’s average revenue and its demand curve?

Answer 39

The demand curve equals the average revenue curve in all cases. This makes sense if you think about what average revenue is, it’s just the total revenue divided by quantity sold, and the price and quantity are both taken from the demand curve.

Question 40

Describe the long-run equilibrium of an oligopoly.

Answer 40

Supernormal profits due to high BTEs.

Question 41

What is the difference between economic and accounting profit? Why do firms survive despite making normal profit (π=0)?

Answer 41

Difference between accounting and economic profit

Accounting profit is the monetary costs (actually chargeable) a firm pays out and the revenue a firm receives. It is the bookkeeping profit, and it is higher than economic profit.

Accounting profit = total monetary revenue - explicit costs (out-of-pocket costs)

Economic profit is the monetary costs, opportunity costs a firm pays and the revenue a firm receives.

Economic profit = total revenue – (explicit costs + implicit costs).
Implicit costs are opportunity costs and do not require an outflow of cash. They cannot be tracked or determined precisely.

Accounting profit: 500 mil (from opp costs: owners put in their own money, taking risks, lending of resources and money which may not be captured under economic profit, hence it does not take into account opp cost)

Economic profit (after paying back money and interests): normal profit (takes into account opp cost)

However, in real life, firms may not pay back the money hence they make.

Question 42

Define total revenue, average revenue, marginal revenue and marginal cost are and illustrate them in diagrams showing their relationships.

Answer 42

TR = PQ 
ATR = TR/Q (TC is at a given level of output while ATC is for each unit of output)

Marginal revenue is equal to the price he receives from the sale of the last additional unit minus the loss of revenue from the sale of all other units at a lower price.

Marginal cost is the change in total costs from increasing output by one additional unit - TC/Q OR TCn - TCn-1.

Question 43

Explain firms’ price and output decisions based on the marginalist principle in maximising profits and revenue.

Answer 43

To maximise profits, firms produce at the profit maximising equilibrium where the firm has no tendency to change its price and output decisions. To do so, a rational firm must make output decisions at the margin by weighing MC against MR, using the marginalist approach to set its output level. Profit maximising equilibrium is only met when MC = MR. This is because when MR > MC, each additional unit of output sold adds more to revenue than it adds to the cost of producing the additional unit. This increases profits for the firm and the firm should increase output. When MC > MR, each additional unit of output produced adds more to cost than it adds to the revenue. This reduces profit for the firm and the firm should decrease output.

To maximise revenue, the firm will produce at the output level where marginal revenue equals to 0 as marginal revenue refers to the price received by the firm from the sale of the last additional unit minus the loss of revenue from the sale of all other units at a lower price.

Question 44

Explain the difference between fixed and variable factors of production.

Answer 44

Fixed factors of production do not change as output changes in the short run. Variable inputs are those that can easily be increased or decreased in a short period of time as output changes in the short run.

Question 45

Explain the difference between short-run and long-run production

Answer 45

Short-run production refers to the time period, in which at least one factor of production is fixed. Long-run production is the time period, in which all the factors of production are variable.

Question 46

Explain the Law of Diminishing Marginal Returns and why it is inevitable in the short run.

Answer 46

Short-run production is subjected to is the law of diminishing marginal returns (LDMR). It states that as more units of a variable factor are added to a given quantity of fixed factors, there comes a point beyond which the additional output from the additional units of the variable factors employed will eventually diminish.

In the short run, as more variable factors are added, output first rises at an increasing rate due to a more efficient labour-capital combination (a division of labour and specialisation of tasks leads to greater efficiency). However, output later rises at a decreasing rate due to inefficient labour-capital combination arising from overcrowding as the fixed factor is being over utilised. LDMR sets in as marginal product (marginal product or marginal physical productivity of an input is the change in output resulting from employing one more unit of a particular input, assuming that the quantities of other inputs are kept constant), each additional unit of labour/variable factor adds to less the total output than previous units of labour. Finally, output falls and marginal product of labour is negative.

In the short run, at least one factor of production is fixed.

Question 47

Explain the difference between explicit costs and implicit costs. Explain the difference between accounting and economic profit. Explain how the 4 are related.

Answer 47

Explicit costs are direct payments made to made to outside suppliers of inputs in the course of running a business, such as wages, rent, and materials (factors not owned by the firm).

Implicit costs are costs that do not involve direct payment of money to a third party but involve a sacrifice of some alternative.

Accounting profit considers the monetary costs a firm pays out and the revenue a firm receives and is always higher than economic profit.

Accounting profit = total monetary revenue - total costs.

Economic profit considers the monetary costs and opportunity costs a firm pays and the revenue a firm receives.

Economic profit = total revenue – (explicit costs + implicit costs).

(Economic profit can be positive, negative, or zero. If economic profit is positive, there is an incentive for firms to enter the market. If profit is negative, there is an incentive for firms to exit the market. If profit is zero, there is no incentive to enter or exit. For a competitive market, economic profit can be positive in the short run. In the long run, economic profit must be zero, which is also known as normal profit. Economic profit is zero in the long run because of the entry of new firms, which drives down the market price. For an uncompetitive market, economic profit can be positive. Uncompetitive markets can earn positive profits due to barriers to entry, the market power of the firms, and a general lack of competition.)

Question 48

Explain the concepts of fixed costs, variable costs, average costs, average fixed costs, average variable costs and marginal cost and to be able to illustrate them in diagrams.

Answer 48

Fixed costs are the cost that does not vary with output and must be paid even production does not take place while variable costs are the cost that varies with output and is not incurred when production does not take place.

TC is the sum of the costs of all the factors of production a firm uses in the production, TFC is the cost incurred in the utilisation of fixed factors of production and TVC is the cost incurred in the utilisation of variable factors of production.

ATC is the cost per unit output.
AFC is the total fixed cost per unit of output.
AVC is the total variable cost per unit of output.
MC is the change in total costs from increasing output by one additional unit - TC/Q OR TCn - TCn-1.
AC = AFC + AVC

Question 49

State and explain the growth maximization objective of firms.

Answer 49

.

Question 50

Explain the factors that affect the size of a firm.

Answer 50

Supply-side / Cost factors
1) Firm that provide services that require personal attention and specific details often reach MES at very low levels of output relative to market output/diseconomies of scale occur at very low levels of output. This is because when specific details need to be mass-produced, any advantages to large-scale production will be offset by disadvantages and the optimum size of firms will be small.

2) Vertical disintegration occurs when a process is broken up into a series of separate processes. Diseconomies of scale quickly emerge in each of these processes so different small firms each performing a small part of the whole task will incur a lower unit cost and they can then complement large firms in the same industry by making specific components.
3) Saucer-shaped LRACs occur when economies of scale are quickly exhausted followed by constant average costs over a wide range of output (breweries). Hence, it would be possible for large and small firms to coexist and be equally cost-efficient and cost-competitive.
4) Banding and joint ventures occur when independent businesses band together to gain the advantages of bulk buying, sourcing for raw materials, advertising and promotion while still retaining their independence/ownership of businesses (its difference compared to mergers). This strategy involves cooperation among smaller firms to protect their interests and obtain economies of scale enjoyed by larger firms. It can help a business grow faster, increase productivity, and generate additional profits.

Demand-side / Revenue factors
5) Market demand may be limited and thus unable to support a large firm.

6) Firms may be small if they produce personalised goods and services which require direct individual attention and cannot be mass-produced or goods which consumers might have a preference for variety and choice rather than standardisation and mass production. (e.g. Legal services, specialized medical procedures provided by surgeons, repair services and hairdressing services)
7) Market segmentation and specialization occurs when an industry caters to a diversified range of products and customers. The industry can then be segmented into smaller markets where large firms focus on mass-produced items and small firms cater to niche markets which may be smaller due to high and restrictive prices. Demand for goods in niche markets tend to be relatively more price inelastic than in mass markets hence although small firms cannot exploit EOS fully, the high prices can cover AC.

Due to geographical factors, perishable goods are sold in smaller localised markets within inaccessible locations as they can only be transported over a limited geographical region. Despite higher AC due to their smaller scale, they can still compete with large supermarket chains.

(Due to profit cycles where new products appear continually and old products disappear, demand for products tend to be low at the early stages of the product cycle and the firm tends to be small as it takes time to grow and outpace rival firms, merge or force others out of the business.)

Business risk and uncertainty: Some firms are unwilling to take greater risks as expansion and large-scale production require funds and starting a larger firm also requires a larger capital outlay. Firms may have to borrow money from banks and incur a greater risk of investment as the losses can potentially be bigger if the business does not succeed. Firms may also fear a future fall in the price of the product as the lack of information on the demand of the good hence a sudden explosion may lead to a large enough increase in market supply which causes a fall in the price of the good. Prospects of lower prices and profits prevent firms from expanding.

Question 51

Discuss how and why firms want to grow in size.

Answer 51

Increase market share, sales and hence profits

Question 52

Discuss why some firms want to remain small.

Answer 52

The alternative objective of firms: Some firms are content with the reasonable income and are unwilling to take risks, stress, perceived challenges in growth, Hence, they have an alternative objective of profit satisficing and enjoy other benefits instead.

Question 53

Explain the shut down condition of a firm.

Answer 53

Total costs (TC) = Total fixed costs (TFC) + Total Variable costs (TVC). In the COVID-19 pandemic, demand is likely to fall and hence Total Revenue (TR) of the firm is likely to fall. If the new lowered TR is still > TC, the firm is making supernormal profits and will continue production.However, if TR falls below TC, it is making subnormal profits and it is necessary to consider TR in relation to TVC to determine if the firm should continue production or shutdown.If TR > TVC, the firm should continue production even if it is making subnormal profits. This is because if the firm shuts down, its losses will be equal to its TFC. However, if the firm continues production, it will be able to cover its TVC and some of its TFC so its losses will be smaller. Hence, the firm minimizes its losses by continuing with production in the short run.If TR falls below TVC (TVC > TR), the firm should shutdown. This is because if it shuts down, it only needs to incur losses of TFC. If it continues production, it will not be able to cover its TFC and some of its TVC and its losses are greater. Hence, the firm minimizes its losses by shutting down temporarily.