Question

Company A is looking to expand. it decides to take over company B, a competitor. The two companies have similar technology, but different costs.

Company A has $1800 fixed costs and $2 marginal cost per unit produced

Company B has $600 fixed costs and $3 marginal cost per unit produced

AT WHAT PRICE LEVEL SHOULD COMPANY A CONSIDOR SHUTTING DOWN IN THE SHORT RUN?

Please explain the process, i am struggling with this thanks

Answer 1

Company A has a variable cost of producing the good, VC = Marginal Cost*Q = $2*Q (Q = Quantity of goods sold)

And Fixed cost, FC = $1800

Suppose the price of the product is P

Then the company will be incurring a loss if,

Loss = VC+ FC - P*Q > 0

(Q = Quantity of good sold)

So, if P < VC/Q + FC/Q

But the firm will be still producing the good if,

P > VC/Q

Because Company A is able to cover a part of its fixed cost and full variable cost also. But if it shuts the operations then it will suffer a loss of fixed cost (as fixed cost cannot be zero in short run), so, he will be better off producing the good even if he is incurring losses if and only if price > marginal cost of producing the good otherwise he will be better of shutting down as he won't be able to cover his variable cost of production, so, losses will be fixed cost plus variable cost and after shutting down loss will be fixed cost only. So, company should consider shutting down at price of $2 or lower.

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