Why might a firm continue to produce in the short run even though the  
market price is less than the average total cost

Hi makbool-ga,

There is no real "textbook" answer for this question - you are
expected more to think about the business environment variables that
surround a firm in this situation.

MARKET (ECONOMIC) CONSIDERATIONS

Market research and other forecasts often lend plenty of insight into
the levels of demand placed on any market. With this in mind, let's
say that this information lead us to believe that there is a
significant increase in demand in the near future. This leads to
several questions:

1. Is this information available to all firms in the market or just
this one?
If all other firms have no idea of the opportunity here, demand will
increase to the point where it exceeds supply. This leaves a niche for
the firm since the market price will undoubtedly rise as a result of
this scenario.

2. How long is this demand increase expected to last?
It is still economically sound to produce at a loss in the short term
if projected profits will cancel out the losses in the long run.

3. Is it worth increasing production when the market takes this turn?
It is often worth taking losses in the short run simply to maintain a
position in the market while waiting for market changes to take place.
Remember that average total cost is:

(total fixed cost + total variable cost)/units produced

So an increase in production levels will lower average total cost and
can lead to increased profits in the long run.

MARKETING/ADVERTISING CONSIDERATIONS

So what happens if we have no information available predicting market
behavior? We have to assume that no change will take place either way
(this is the least risky) and attention now turns to method for
increasing current market share. This involves making changes to the
firm's "marketing mix", in other words, how it handles pricing,
promotion, distribution, and the product itself.

These changes will obviously not take effect immediately, but if it is
projected that they will recoop more profits than the amount be lost
waiting for changes to have their effect, it is worth continuing
production at a cost above market price, again to maintain position in
the market.

Hope this helps :)

answerguru-ga

yes it did help me to understand the concept better

I would think that another reason, in addition to anticipating a rise
in market price would be if one were also expecting a rise in the
production cost. In that case, producing now at a small loss may
prevent production at a greater loss, or allow a profit later, when
prices rise due to cost increases. Kind of like locking in a lease at
a slightly higher then norm interest rate, because you expect lease
rates to jump, OR you expect the price of the land/property to jump
more then the extra interest being paid.

Another issue that is very relevant here is the possibility of
predatory behaviour by producer: assuming the producer is efficient
(or at least no less efficient than any other incumbent), then if the
firm is able to keep on producing at this higher cost longer than
other incumbents, there will eventually be exist from the market. This
will increase the market power of the producer, and possibly lead to
an increase in the market price.
Further considerations that are relevant include interdependent
demands, issues with upstream/downstream markets and so on.

I feel these are the more standard "text book" reasons for the
described behaviour. Any textbook on IO will have lengthy discussions.

Antti

I know the question has already been answered, but I think these
answers have missed the 'textbook' definition of short run.

The short run is defined as the period in which variable inputs can be
changed, but the 'fixed' inputs cannot. For example, if the short run
were 1 week, a firm might be able to change the number of workers, but
it cannot relocate to a larger plant, nor change the capital stock.

Now, if a firm produces a quanity of 0, it has a variable cost of 0.
However, it still pays the fixed cost. So a firm in this example is no
longer a profit maximising firm, but a loss minimising firm (until it
can exit the market and close it's operations. ie. go out of business
and stop making losses).

Loss minimisation and profit maximisation are essentially the same.
The firm, stuck with a fixed cost no matter what it does, is stuck
making a loss. But it might minimise it's loss by actually producing
and selling.

I hope that clears up this rather bizzare firm behaviour, but it's a
rather textbook case :)

--Bluebeard