· Average Fixed Cost = $2 · Average Variable Cost = $1 · Marginal Revenue = $1.5
ID: 1247182 • Letter: #
Question
· Average Fixed Cost = $2· Average Variable Cost = $1
· Marginal Revenue = $1.50
a) Other things constant, should your friend continue to operate in the winter months? Be sure to explain to her why she should or should not continue to operate.
b) In the following year, your friend asks for your help again. All of the data remain the same; however your friend finds that she is no longer profitable in the spring, summer, or fall months. What advice would you give to her under these circumstances? Why?
Explanation / Answer
As long as you are making variable margin (revenue greater than variable costs) you should stay open in the short term. This is because your fixed costs are not going to go away and therefore you reduce your losses when you stay open and make some variable margin to offset a portion of them. Longer term, however, all costs become variable. If you cannot cover all of your costs and make a profit in the long term you should shut down.
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