*URGENT* why might a firm keep producing in the short run even if it is suffering a loss?

Question

and how does the price elasticity of demand affect which products the gov. liek to tax?

i got my final exam in 2 hours

Answer 1

Because in short-run firm has fixed costs and it should pay it whatever it produces something or not, thus if firm can cover at least part of these inevitable fixed costs it will do so, but first it should cover variable costs as first priority. So firm will choose to produce until it covers variable costs plus some extra of fixed ones.

Elasticity of demand helps gov to decide who will bear most of the tax (if supply is less elastic then producer will pay bigger share of tax, but if demand is less elastic then more of the tax will be levied on customers).

Answer 2

A firm might keep producing in the short run even if it is suffering a loss if it believes that other firms may drop out.  This is not uncommon in the real world, where a dominant player will operate at a loss in the short run, attempting to drive out competitors...after which, it would be able to raise prices and make a profit.

Regarding taxation, in general, the greater the elasticity of a good, the more people will react to a tax being placed on the good and the greater the excess burden of the tax.  Essentially, you would like to impose taxes without distorting market outcomes.  Ideally, you would like to impose taxes without changing consumption decisions.  One way to do this is impose taxes on goods with lower elasticities.  The price elasticity of demand for cigarettes is low, so they make a nice target for taxes (not to mention that discouraging smoking is seen as a societal good).  There are limits to this strategy, however, as heavily taxing some goods with low elasticities...like insulin...could be seen as being grossly unfair.