Should a firm shut down (and why) if its revenue is R= 1,000...

Should a firm shut down (and why) if its revenue is $R=\$ 1,000$ per week
a. its variable cost is $V C=\$ 500,$ and its sunk fixed cost is $F=\$ 600 ?$
b. its variable cost is $V C=\$ 1,001$, and its sunk fixed cost $F=\$ 500 ?$

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Key Concepts

Sunk Costs

Sunk costs refer to costs that have already been incurred and cannot be recovered. In decision-making, particularly in the context of whether to continue operations, these costs are considered irrelevant because they should not affect future economic decisions since they cannot be altered by any current or future actions.

Variable Costs

Variable costs are expenses that change in direct proportion to the level of output. In the shutdown decision, the key comparison is between the firm's revenue and its variable costs, because these costs must be covered each period to avoid incurring further losses when production continues.

Shutdown Decision Rule

The shutdown decision rule in microeconomics suggests that a firm should continue operating in the short run if its revenue covers its variable costs, even if it incurs a loss by not covering fixed costs. If the revenue does not cover the variable costs, the firm minimizes its losses by shutting down, because continuing to produce would worsen the overall financial outcome.

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