Question

A firm is experiencing a loss of $5,000 per year. The firm has fixed costs of $8,000 per year.a. Should the firm operate in the short run or shut down?b. If the situation persists into the long run, should the firm stay in the market or go out of business?c. Now suppose that the firm’s fixed costs are $2,000. How would this level of fixed costs change the firm’s short-run and long-run decisions? Show work.

Answer 1

Answer:

(a) Continue to operate.

(b) Shut down

(c) Continue to operate.

Explanation:

(a) It is given that the firm will experiencing a loss of $5000. Therefore, it means that a loss of $5,000 is borne by the producer of the fixed cost. It is a portion of fixed cost but the firm will continue to operate in the short run if it covers all of the variable cost in the short run.

(b) The firms in the long run try to cover all of its variable and fixed cost. If this situation persists then this firm unable to cover its all costs. Therefore, the firm will shut down its operation and go out of the business.

(c) Now, if the firm’s fixed costs are $2,000.

There is a reduction in the fixed cost by $6,000

Previously firm able to cover = $8,000 - $5,000

                                                = $3,000

It means that it cover its fixed cost and hence, the firm will operate in both short run and long run.