Bob's lawn-mowing service is a profit-maximizing,...

Bob's lawn-mowing service is a profit-maximizing, competitive firm. Bob mows lawns for $\$ 27$ each. His total cost each day is $8280,$ of which $\$ 30$ is a fixed cost. He mows 10 lawns a day. What can you say about Bob's short-run decision regarding shutdown and his long-run decision regarding exit?

Key Concepts

Fixed and Variable Costs

Understanding the distinction between fixed and variable costs is critical. Fixed costs do not vary with output and are incurred even if production is halted, whereas variable costs change with the level of output. This distinction is key in evaluating shutdown and exit decisions because fixed costs can be ignored in the short-run shutdown decision, but both fixed and variable costs matter for long-run viability.

Long-Run Exit Decision

In the long run, all costs are variable and the firm must cover the total costs, not just the variable costs. A firm will exit the industry if it cannot earn enough revenue to cover its average total cost (ATC) in the long run. Persistent losses will eventually force a profit-maximizing firm to exit.

Perfect Competition

In a perfectly competitive market, firms are price takers, meaning they cannot influence the market price and must accept it as given. Their production decisions are based on the market price, and they choose output levels by equating their marginal cost to the market price to maximize profits.

Short-Run Shutdown Decision

In the short run, a competitive firm will continue operating as long as the price covers its average variable cost (AVC), even if it is making an overall loss, because fixed costs are sunk in the short run. If the market price falls below the AVC, the firm minimizes its losses by shutting down production.

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