Say you are the manager of a perfectly competitive firm selling a product. Your

Question

Say you are the manager of a perfectly competitive firm selling a product. Your business is making a loss because total revenue is less than total costs. What would you do--shut down or continue to operate? Use hypothetical numbers to explain. Information you need to provide include--state the product you are selling, the price of the product, the quantity of the product you produce, fixed costs, total cost, figure out total revenue, total and average variable costs. Then go ahead and make your decision. Explain carefully why it makes better sense to shut down rather than continue to operate or to continue to operate rather than shut down, as the case may be. How do fixed costs play a role in your analysis? What is the difference between shutting down and going out of business?<?xml:namespace prefix = o ns = "urn:schemas-microsoft-com:office:office" />

Explanation / Answer

When a seller is making a loss, and its price or marginal revenue is still higher than it average variable cost, although average cost is higher than price, it can continue to operate (if he is in shortrun bc his revenue although lower than cost will still be able to cover it's average variable cost). Although it is not making profit but it can still cover its variable costs (cost of variable factors like wages, salaries,etc).
But if the firm's price or marginal revenue is lower than the average variable cost, the firm will be advised to shutdown. When the firm shuts down, it doesn't mean it has gone out of the business, but it mean it will produce no more since the firm will make higher loss as it increases output and it will not be able to pay labour. Although it will still settle its fixed cost bc these fixed cost are there regardless of what happens unless the firm leaves the industry.

Shutting down means to stop operation although the firm is still inexistence. This is always done in a situation where MR<AVC so as to avoid the payment of AVC although AFC will still be paid regardless of whether the firm operates or not.
While getting out of business is the liquidation of the firm, this is always down whenever AVC is greater than MR in the long run. Here, the firm is free of all costs. And it's existence is terminated

Fixed cost is not used to determine whether a firm should continue operation or shutdown. Therefore, in a decision like this the FC or AFC is not important.

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