Question

Stu owns an ice cream parlor that is usually closed during the winter. This winter, however, Stu is considering opening his business in February instead of March. If Stu opens his store in February, he will earn total revenue of $4,000 for the month, incurring variable costs of $3,500 and fixed costs of $1,500. If the store remains closed during February, Stu will earn no revenues and incur fixed costs of $1,500. Stu should:
a) open in February because the $4,000 of total revenue exceeds the $3,500 of variable costs.
b) stay closed in February because he will lose $1,000 if he opens.
c) stay closed in February because the $500 of operating profit is insufficient to cover the $1,500 of fixed costs.
d) open in February because the $4,000 of total revenue exceeds the $1,500 of fixed costs.

Answer 1

Answer:

a) open in February because the $4,000 of total revenue exceeds the $3,500 of variable costs.

Explanation:

In the short run, when the demand for a product decreases below break even point, a business should remain in operations as long as the total revenues are equal or larger than variable costs.

In this case Stu will only earn $4,000, which is not enough to make a profit, but will cover all the variable costs. If he remains closed during February, he will still have to pay $1,500 in fixed costs.