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Firstly, we understand the meaning of firm that will help us to understand the above statement.

A production unit under the control of an entrepreneur who aims at maximisation of profit.

Now, we will discuss why firms facing problems when sometimes production is continued even with loss.

When firms not leave industry, why do they not at least close down, that is stop producing when they are incurring losses? The reason behind this, is that short run is a period during which the firms cannot alter their fixed capital equipment. Therefore if the firms close down the production, even they will have to bear fixed costs in the short run, only variable costs can be avoided by stopping production in the short run.

It other words, it clearly indicates that if the firm stops production in the short run, it can avoid only variable costs, fixed costs will have to be bear by it in the short run whether it is producing or not.

If in the short run the firm can earn revenue which covers the whole of variable costs and a part of fixed costs, it will be rational for it to continue production since stopping production under such situations will mean greater losses.

It means, the firms will remain in business and continue production in the short run, so long as it can cover whole of the variable cost and a part of fixed cost. This means that price, though less than average cost, must be equal to or greater than average variable cost.

If price is less than average variable cost, the firm will not be able to cover even variable cost, so that losses will increase if production is continued. It would be prudent to discontinue production in this circumstances.

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