At its best possible output level, a firm has total revenue...

At its best possible output level, a firm has total revenue 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?

Key Concepts

Short-run Shutdown Decision

The short-run shutdown decision revolves around whether a firm's total revenue is sufficient to cover its total variable costs. If the revenue at the best output level does not cover variable costs, the firm minimizes losses by shutting down, thereby avoiding additional variable costs. Conversely, if revenue exceeds variable costs, continuing production minimizes the overall loss because the firm is contributing towards covering its fixed costs.

Contribution Margin

The contribution margin is calculated as total revenue minus total variable costs. It represents how much revenue remains to cover fixed costs. A positive contribution margin means that production helps reduce the overall loss because it contributes to covering fixed costs, even if total profit is negative. This concept is central for decisions where a firm must choose between continuing production or shutting down in the short run.

Variable Costs

Variable costs vary directly with the level of production. They are incurred only when output is produced, and they can change as production volume changes. In production decisions, comparing total revenue to variable costs helps determine if production covers the costs directly attributable to manufacturing, thus serving as a key parameter in the shutdown analysis.

Fixed Costs

Fixed costs are expenses that do not change with the level of output in the short run. They represent costs that the firm must incur regardless of production levels and are considered sunk in the short run. This concept is essential when making production or shutdown decisions because these costs will be incurred whether or not the firm produces any output.

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