Question

A firm has hired you as a consultant. This firm is perfectly competitive and has no control over price. This firm is selling 10,000 units at a price of $3. Total costs are $40,000. Total variable costs are $35,000. They can produce another unit at a cost of about $3. What do you recommend?

shut down

continue to operate at a loss in the short run

decrease quantity

increase quantity

Answer 1

Shut down

Variable costs are $35000 and total costs are $40000. That means fixed costs are $5000.

Now, the revenue earned is 10000 X 3 (Price multiplied by quantity sold) = $30000

The revenue does not even cover variable costs. The firm is in loss of fixed as well as variable profits. Had the revenues covered at least variable costs and not fixed costs, the firm could have survived. But in this case, when the revenue are less than even variable costs of production, there is no other option available than shutting down the business.

That’s what a rational producer would do.