Question

Short answer: Using restaurants as an example, explain the shutdown decision many firms are facing with the economic slowdown due to coronavirus. Explain the factors influencing the shutdown decision and how these are applied int eh short and long run.

Answer 1

Restaurant owners are facing to take decisions regarding continuing the operations  or shutdown due to the economic slowdown as a result of COVID-19 crisis. Here, restaurant owners have to consider the demand level of their products, average variable cost (AVC) and price in the short run, while they have to consider price and ATC in the long run. Since restaurants have variable cost in the form of workers' wages, expenses in raw materials and lower shelf life of the food, the they have AVC at a level in their restaurant business. If they find that price due to lower demand is less than AVC, then they shutdown in the short run. If not, then they continue even if they incur the losses in the short run. In the long run, they change strategies, bring more capital and then, if they have ATC to be higher than the price, then they shut down in the long run. If not, then they continue in the long run.

Factors affecting the shutdown decision is the demand level, number of competing restaurants and ability to change factors of production. In the short run, an increase in demand level leads to increase in price, that helps restaurants stay in the market and vice versa. Increase in competing restaurants is going to increase supply and price level decreases. It can make price to be less than AVC and become a basis for the restaurants to shutdown.

In the long run, firms are able to change factors of production and if it makes ATC to be lower than price, then they stay in the market and if not, then they shutdown. Demand and other competing restaurants also affect the  market as it happens in the short run.