Question

\(\mathrm{Al}\) and George's used car lot has total revenue of \(\$ 5\) million, fixed costs of \(\$ 8\) million, and variable costs of \(\$ 4\) million. In the short run the firm will__________ and in the long run it will \((\mathrm{LO8})\)__________ a) shut down, go out of business b) shut down, stay in business c) operate, stay in business d) operate, go out of business

Short answer

In the short run, Al and George's used car lot will operate, and in the long run, they will go out of business.

Step-by-step solution

Calculate Total Costs

To calculate the total costs, we need to combine the fixed and variable costs: Total Costs = Fixed Costs + Variable Costs = \(8 million + \)4 million = $12 million

Compare Total Revenue with Total Costs

Now, we need to compare the total revenue with the total costs: Total Revenue = $5 million Total Costs = $12 million In this case, our total costs exceed the total revenue.

Determine Short Run Action

In the short run, a business should continue to operate if it can cover its variable costs, since the fixed costs have already been incurred and cannot be recovered. Let's compare the total revenue with the variable costs: Total Revenue = $5 million Variable Costs = $4 million Since the total revenue can cover the variable costs (\(5 million > \)4 million), the car lot should continue to operate in the short run.

Determine Long Run Action

In the long run, a business should continue to operate if it can cover both its fixed and variable costs with the generated revenue. We've already established that the Total Costs exceed the Total Revenue (\(12 million > \)5 million). This means that Al and George's used car lot cannot cover both fixed and variable costs in the long run. Using the analysis in Step 3 and Step 4, we can now select the correct answer from the given options: a) shut down, go out of business b) shut down, stay in business c) operate, stay in business d) operate, go out of business The correct answer is: (d) operate, go out of business.

Key concepts

Total Revenue

Total revenue is a crucial concept in business decision-making. It refers to the total amount of money a company earns from selling its goods or services. In the context of Al and George's used car lot, the total revenue is expressed as \( \\(5 \text{ million} \). This revenue comes from all the cars they manage to sell.

Understanding total revenue is essential because it helps businesses determine whether they are profitable or not. If a business's total revenue exceeds its costs, it means the company is making a profit. However, if the total revenue is less than the total costs, like in this case, it indicates a loss.

For Al and George, total revenue of \( \\)5 \text{ million} \) falls short compared to their total costs, which include fixed and variable costs. This assessment forms the basis for their decision-making, which takes different shapes in the short run versus the long run.

Fixed and Variable Costs

Fixed and variable costs are two major types of costs that every business needs to consider. Fixed costs are expenses that remain constant, regardless of the level of production or sales. These might include rent, salaries, and insurance. For Al and George's used car lot, fixed costs are \( \\(8 \text{ million} \).

Variable costs, on the other hand, are expenses that change with the level of production or sales. They could include things like materials and labor costs that vary with output. Here, the variable costs are \( \\)4 \text{ million} \).

The sum of fixed and variable costs represents the total costs, which for Al and George amount to \( \\(12 \text{ million} \). Since these costs exceed the total revenue (\( \\)5 \text{ million} \)), it indicates that the car lot is running at a loss.

Understanding these costs helps Al and George decide their actions in both the short and long run, as these costs directly impact their business's sustainability.

Business Shutdown

The concept of a business shutdown involves evaluating whether a company can continue operations based on its cost and revenue structure. Generally, businesses have different strategic decisions in the short and long run regarding shutting down.

In the short run, a business like Al and George's used car lot needs to determine if its revenue can at least cover its variable costs. For example, their total revenue of \( \\(5 \text{ million} \) meets their variable costs of \( \\)4 \text{ million} \). Thus, the car lot can afford to remain operational in the short run, because fixed costs are already incurred and irrelevant in the short run shutdown decision. This shows why they choose to operate in the short run.

However, in the long run, businesses must cover both fixed and variable costs. Since their total costs are \( \\(12 \text{ million} \) and their revenue is only \( \\)5 \text{ million} \), they cannot sustain this in the long run. Therefore, Al and George's business is likely to shut down eventually due to its inability to cover all costs, leading them to the ultimate decision to "operate, go out of business" in the long run.