DIAGRAM: From economicsmicro.blogspot.com
Lets say the firm itself is making an subnormal profit- a loss it must decide whether or not to leave the market or not. If it decides to leave the market a question is when is the right time to?
This is where the price and average variable cost is accounted. If in the short run where at least one factor of production is fixed, if it decides to exit the market now it will have to pay the fixed costs aswell. Markets have to consider if they can help to ease the fixed costs and if they able to it is better to otherwise all the money has to come out the owner’s pocket.
So if Price> Average Variable Cost therefore they can help contribute to the fixed costs For example for 100 units the cost of the good is £50 so the total revenue is £5000. While Average variable cost is £40 so the total variable cost is £4000. Average total cost is £6000 is is only making a £1000 loss. Which is payable and is better than paying the whole £2000 cost.
However if the price< average variable cost therefore there is no point in carrying on. Lets say it is £30 per unit so it is £3000 revenue and total variable cost is £4000 is it is a £1000 loss plus then also a £1000 fixed cost.