Question

Many small businesses have had to decide to whether close or remain in business during the recent pandemic. This is especially true of many local restaurants. Some have decided to adjust their services to take-out or delivery only, while others have decided to shutter completely or shut-down in the short-run. Assuming that the market for restaurant food is perfectly competitive and all restaurants face fixed costs in the short run for things such as rent or mortgage payments, describe why some may minimize losses by shutting down completely while others have decided to continue to produce and serve food via take-out and delivery in the short-run. In your explanation, describe what role fixed and variable costs play in the decision process.

Please answer in at least 2 paragraphs

Answer 1

We must understand the consept of fixed costs and variable costs to address this question. Fixed costs are costs a firm undertakes before starting the first unit of production. This generally comprises of large capital costs like buying machineries, building infrstructure etc. In the case of restaurent, this fixed cost may be cost of building the restaurent, buying tables and chairs, stocking kitchen with utensils etc. On the other hand variable costs are the ones, that are undertaken periodically with each successive unit of production. For a restaurent, this may include costs of waiters, electricity etc.

Now, during the lockdown some have chosen to work with constraints as given in the question. This decision is due to the fact that they are able to cover their variable costs, that is they are able to take away some profit with minimal variable costs and thus they are better off keeping restaurents functional. For those who have shut down, they are not recovering their variable costs and sue to which must be occuring operating losses. Thus, the wiser decision for them is to shut down. The fixed costs don't play a role here, because they are sunk costs, i.e. they are already undertaken and you lose them regardless of what you decide.

Thus, variable costs are the primary decision making factor. Those who are covering their variable costs are running and those who aren't are shut down.

Thanks!