Question

Which of these statements is false? (LO8) a) When the firm shuts down, output is zero. b) When variable cost is zero, output is zero. c) When output is zero, total cost is zero. d) None of these is false.

Short answer

Statement C: When output is zero, total cost is zero. This statement is false because even when output is zero, the firm still has fixed costs to cover.

Step-by-step solution

Statement A: When the firm shuts down, output is zero.

This is a true statement. When a firm decides to shut down, it stops producing any goods or services, and so its output becomes zero.

Statement B: When variable cost is zero, output is zero.

This is not necessarily true. Variable costs are costs that change as a firm produces more output. If variable costs are zero, it means the firm has no costs that change with output. However, this doesn't necessarily mean that the output is also zero, because the firm could still be producing something with fixed costs.

Statement C: When output is zero, total cost is zero.

This statement is false. When output is zero, it means the firm is not producing any products. However, even if the firm is not producing anything, the total cost is not necessarily zero. The firm still has to cover fixed costs, such as rent, utilities, and salaries - all of which are incurred regardless of production levels. Thus, the total cost does not become zero just because the output is zero.

Statement D: None of these is false.

Since we have already established that Statement C is false, this statement is also false.

Key concepts

Variable Costs

Variable costs are a fundamental concept in microeconomics, referring to costs that change with the level of production output. These costs increase or decrease depending on the firm’s production. When a firm produces more, variable costs rise; when production is scaled back, these costs fall.

• Examples of variable costs include raw materials, direct labor costs, and utility expenses linked to production.
• Variable costs are crucial for a firm as they directly impact its decision-making regarding production levels.
• These costs are distinguished from fixed costs, which remain constant regardless of output.

In the context of the exercise, it's important to note that if variable costs are zero, it doesn't automatically mean that production is zero. A firm might incur no variable costs but still use fixed resources to maintain some level of production.

Fixed Costs

Fixed costs refer to any operational expense that remains constant, regardless of a firm's level of output. These costs do not vary with the production levels and must be covered whether the firm is actively producing goods or not.

• Typical fixed costs include rent, salaries, insurance, and loan payments.
• These costs are vital for ensuring the basic functions and operations of a business, even when production halts.
• Understanding fixed costs helps a firm in calculating its break-even point and in making critical financial decisions.

The exercise highlighted that even if a firm's output is zero, its total costs are not zero due to these fixed costs. Thus, understanding the nature of fixed costs is essential for accurate cost analysis.

Shutdown Decision

A shutdown decision refers to a scenario where a firm must decide whether it is more advantageous to temporarily cease production. This decision is based on a comparison of revenue and costs, particularly focusing on variable costs.

• If the revenue generated from production does not cover the variable costs, the firm might opt to shut down operations.
• A shutdown is distinct from closing permanently and is often considered a short-term measure during economic downturns.
• The critical criterion for a shutdown decision is whether the firm can cover its variable costs with the revenue generated.

The exercise clarified that if a firm shuts down, its output falls to zero. This is a true statement, as shutting down means halting production entirely. The firm avoids incurring variable costs but still needs to address fixed costs. This decision can help a business minimize losses until conditions improve.