Question

Think about Major League Baseball! The owners of the major league teams are arguing that they may have to shut the season down unless the players agree to a significant salary cut. If the players agree, the owners will be able to play games this season.

Explain loss-minimization and shut down cases for perfectly competitive firms. Explain why baseball owners may have to resort to a shut-down case and why they may be able to use a loss-minimization case.

Answer 1

Loss minimization is a case when perfectly competitive firms produce the output that can minimize their economic loss. It is done when price is higher than the AVC, but lower than the ATC. So, firms want to operate, but try to minimize the losses as well in the short run. The Shutdown is the case, where firms go out of market if price is less than the AVC. It means that more they produce, higher they incur the economic losses. Hence, the price should must be equal to or more than AVC to continue their operations.

In the context of Major league baseball, the teams are also behaving like perfectly competitive firms and salaries paid to the players are going to increase their ATC and AVC. It forces to make players take salary cut so that they can play games. If it happens then, price is going to be higher than AVC, to prevent shutdown and implement shutdown case. At the same time, if price is greater than AVC, but less than ATC, then they can minimize the losses if players take the salary cut. Hence, loss minimization also takes place for them. Hence, the team owners apply these two cases to remain operational in the league. If not, they will go out of the league and not play this season again.