Question

3. A firm sells 300,000 units per week. It charges $45 per unit, the average variable costs are $40, and the average total costs are $55. a. The company’s lease (fixed cost) expires in six months and they need to decide whether to renew. Should they? Explain why or why not. b. At what price would the firm consider shutting-down before the lease expires?

Answer 1

a)

total cost =average total cost *quantity

=300000*55

=16500000

total variable cost=average variable cost *quantity

=300000*40

=12000000

fixed cost =total cost -variable cost

=16500000-12000000

=4500000

profit=(price-ATC)*Q

=(45-55)*300000

=-3000000

The firm is making losses but the firm is making losses less than fixed cost so the firm will produce up to the lease expire to minimize losses because if the firm shut down the loss is equal to the fixed cost. It means the firm will leave the industry in the long run. It will not renew the lease.

b)

A firm shut down if the price is below AVC means the loss in short run is above fixed cost then the firm shut down to minimize losses.

In this case, the firm will shut down if the price goes down $40.