Question

Harry Houdini's Prestige Magic Shop is losing money because price is below average cost. He asks his friend Henry for advice. Regarding Henry's advice, what should he tell Houdini to do in the short run?

He should figure out his opportunity cost; if his opportunity cost is greater than his accounting profit he should shutdown.

He should figure out his opportunity cost; if his opportunity cost is greater than his economic profit he should shutdown.

He should figure out his fixed costs; if his fixed cost is greater than his price, he should shutdown.

He should figure out his average variable cost; if his average variable cost is greater than his price he should shutdown.

Answer 1

A firm will shut down only in a situation when it is not able to cover its variable cost. Generally firm does not focus on its fixed cost or opportunity cost because opportunity cost and fixed cost plays an important role in the long run as if opportunity cost cause economic losses in the short run then it does not mean that it will shut down in the short run. So firm should shut down its operation when Price is less than average variable cost.

Option 4th is correct: He should figure out his average variable cost; if his average variable cost is greater than his price he should shutdown.