Question

Suppose that in the second year her average total cost per dog is $35 and that $20 of that is associated with the variable cost. She finds that the market price for dog grooming has fallen, however, to $30 per dog. Should she stay open or close the business? Briefly explain your answer.

Answer 1

Answer:

She should stay open, because the revenue of from dog grooming ($30 per dog), is still high enough to cover her variable cost of $20 per dog, even though she is operating at a loss.

Explanation:

Profit = Revenue - Total costs

Total costs = Fixed costs + variable costs

Profit = $30 - $35 = -$5 per dog

This shows she is operating at a loss of $5 per dog.

If a company does not make enough revenue to cover its total costs, then it is operating at a loss.

However such a company must consider its variable cost before deciding whether to shut down.

A company should only shut down if it is unable to make enough revenue to cover its variable cost.

If a company is operating at a loss but can at least cover its variable cost, then it should stay open at least in the short run.