Question

At its best possible output level, a firm has total revenuc of \(\$ 3,500\) per day and total cost of \(\$ 7,000\) per day. What should this firm do in the short run if: a. the firm has total fixed costs of \(\$ 3,000\) per day? b. the firm has total variable costs of \(\$ 3,000\) per day?

Short answer

In scenario A, the firm should shut down as total revenue is not covering variable costs. In scenario B, the firm should continue operations despite losses as it can cover its variable costs.

Step-by-step solution

Assess Scenario A

In the first scenario, it's given that total fixed costs amounts to \(\$3,000\) per day. First thing to do is calculate the firm's total variable costs, which can be found subtracting fixed costs from total costs. So, total variable cost = total cost - total fixed cost = \(\$7,000 - \$3,000 = \$4,000\).

Determine Action A

Next decision is based on whether total revenue is greater or lesser than total variable costs. Here, total revenue is \(\$3,500\) which is less than total variable cost \(\$4,000\). Therefore, in scenario A, the firm should shut down in the short run as they are unable to cover their variable costs.

Assess Scenario B

In the second scenario, it's given that total variable costs amounts to \(\$3,000\) per day. This means the remainder of the total cost (\$7,000) are fixed costs, which everyday amounts to \$4,000.

Determine Action B

The decision is again based on whether total revenue is greater or lesser than total variable costs. In this case, total revenue is \(\$3,500\) which is greater than total variable cost \(\$3,000\). So, despite making a loss, the firm should continue operations in the short run as it is able to cover its variable costs.