The correct answer is: A perfectly competitive firm should reduce output or shut down in the short run if market price is equal to marginal cost, and the price is less than average variable cost.
A perfectly competitive firm is a price taker, which means that it cannot influence the market price of its product. The firm’s marginal cost curve intersects its average variable cost curve at the minimum point of the average variable cost curve. If the market price is equal to or greater than the average variable cost, the firm will produce at the point where marginal cost equals price. However, if the market price is less than the average variable cost, the firm will not produce any output, because it will lose money on every unit produced.
Here is a diagram that illustrates the concept:
[Diagram of a perfectly competitive firm’s cost curves]
The firm’s marginal cost curve is MC, its average total cost curve is ATC, and its average variable cost curve is AVC. The market price is P. If the market price is equal to or greater than the average variable cost, the firm will produce at the point where marginal cost equals price. However, if the market price is less than the average variable cost, the firm will not produce any output, because it will lose money on every unit produced.
In conclusion, a perfectly competitive firm should reduce output or shut down in the short run if market price is equal to marginal cost, and the price is less than average variable cost.