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?
If a firm temporarily suspends production due to matters of financial loss, is a shutdown of business, if a firm opts to “go out-of-business” primarily due to continual financial losses the business is inoperable and no longer conducting transactions.
My firm produces unique custom women shoes. This is a web based business which employs 5 designers including myself. The shoes feature materials such as feathers, spikes, studs, and jewels. The most popular shoe is the jeweled shoes, specifically the Crystal pump, this shoe is priced at $500. The company goal is to produce 25 shoes per week. There are 5 designers on the team including myself. The fixed cost is $5,000 per month which includes employee wages, business maintenance, and advertising. The total cost is $17,500. Suddenly business has slowed and we are only producing 10 shoes per month. It would be more beneficial for the business to remain operable and produce as orders are received. Although we are losing 10,000 per month, I am still able to afford the fixed cost. Since the entire staff is not needed in production of lower quantities of the product, I can temporarily lay-off and save by paying off less in wages. The fixed cost plays a major role in continuation of operation because without business maintenance, products could not be produced, nor could wages be paid to employees. Also, lack of visual recognition would hinder attracting more clients, if we were unable to advertise. If we continue to work as normal production will eventually resume to full capacity. Any unresolved debt would be settled at that time.
I feel that my business would be selling Video Games.
Now there would pretty much be a fixed price of $60 for the new games. and roughly $30 for the moderately old, and then any where from 10-5 for the really old games.
These prices are, if I am correct, decided by the company that produced the game. I would just be retail.
Now as for closing the store...I wouldn't. I would attempt to stay open for as long as I could. After all, starting a business about becoming an Entrepreneur. A risk taker. So if you try to take the safe route you won't make any money.
Now as for the decrease in revenue. Perhaps it's just a phase, this particular industry has those phases, because sometimes it'll take a good popular game to be able to spark something. Another thing to take into account is the amount of competition that is near by. If there is too much competition, you'll have to think of a unique way to make your stuff stand out.
Now as far as fixed costs go, you can't just freely change the prices...so competition can be a little difficult to deal with. But it also makes it a pretty even race. It mostly matters at this point how close you are to most of the public, or if your in a populated area.
Well the question however, was that which made more sense.
I suppose shutting down makes more sense, since your essentially not making money, and it's pretty obvious your not gonna make any money any time soon. It lets you get out while your ahead if you think of it that way.
As the manager of a perfectly competitive firm selling a product, let's say the product is widgets. Here are the hypothetical numbers:
- Price of the product: $10 per widget
- Quantity of widgets produced: 1,000
- Fixed costs: $5,000
- Total costs: $8,000
To calculate total revenue, we multiply the price of the product ($10) by the quantity produced (1,000), which gives us $10,000.
To calculate total variable costs, we subtract the fixed costs ($5,000) from the total costs ($8,000), which gives us $3,000.
To calculate average variable costs, we divide total variable costs ($3,000) by the quantity produced (1,000), which gives us $3 per widget.
Now, let's analyze the situation:
1. If total revenue is less than total costs (in this case, $10,000 < $8,000), the firm is making a loss.
2. If the firm shuts down, it stops producing widgets temporarily and incurs no variable costs. However, it still has to pay the fixed costs of $5,000. So, the firm's total costs if it shuts down would be the fixed costs ($5,000).
3. If the firm continues to operate, it will still incur variable costs of $3 per widget, as well as the fixed costs of $5,000. So, the firm's total costs if it continues to operate would be the sum of fixed costs ($5,000) and variable costs ($3 per widget multiplied by 1,000 widgets, which is $3,000).
Based on this analysis, it makes more sense to shut down rather than continue to operate. By shutting down, the firm limits its costs to just the fixed costs ($5,000), which is lower than the total costs if it continues to operate ($8,000). The firm would be incurring a smaller loss by shutting down.
It's important to note that shutting down does not necessarily mean going out of business. Shutting down refers to temporarily stopping production, while going out of business implies permanently closing down the firm. In this scenario, shutting down means the firm is halting operations but can resume production when conditions improve or change, whereas going out of business means the firm is permanently closing and will not resume operations.
To make a decision between shutting down and continuing to operate, let's consider the following hypothetical scenario:
Product: Let's say you are selling smartphones.
Price of the product: Assume you sell each smartphone for $500.
Quantity produced: Assume you produce 1,000 smartphones.
Fixed Costs: These are costs that do not change regardless of the level of production. Let's say your fixed costs for running the business, such as rent, utilities, and administrative expenses, amount to $10,000.
Total Costs: This includes both fixed costs and variable costs. Variable costs are costs that change with the level of production. Suppose your variable costs for each smartphone amount to $300.
Total Revenue: This is the total amount of money generated from selling the product. In this case, it is calculated by multiplying the price of the product by the quantity sold. Total Revenue = Price × Quantity = $500 × 1,000 = $500,000.
Total Variable Costs: This is the total cost of production excluding the fixed costs. In this case, it is calculated by multiplying the variable cost per smartphone by the quantity produced. Total Variable Costs = Variable Costs per Unit × Quantity = $300 × 1,000 = $300,000.
Average Variable Costs: This is the variable cost per unit of production. It is calculated by dividing the total variable costs by the quantity produced. Average Variable Costs = Total Variable Costs / Quantity = $300,000 / 1,000 = $300.
Now let's analyze the situation:
Total Revenue ($500,000) is less than Total Costs ($310,000), which includes both fixed and variable costs. This means the firm is making a loss of $210,000 ($500,000 - $310,000).
Fixed costs play a role in the analysis by creating a baseline level of expenses that need to be covered. In this case, the fixed costs amount to $10,000.
Shutting down refers to temporarily stopping production but keeping the business intact, while going out of business means permanently closing down the business.
Based on this scenario, it would make more sense to shut down rather than continue to operate. Here's why:
If you continue to operate, you will incur a loss of $210,000. This loss is more than the fixed costs of $10,000. Therefore, it would be economically rational to shut down temporarily and wait for market conditions to improve. By shutting down, you avoid incurring further losses and can reassess your options.
While shutting down temporarily allows you to save on variable costs, it does not eliminate fixed costs. These costs will still need to be paid even during the shutdown period. However, by shutting down, you avoid further losses and have the opportunity to evaluate and adjust your business strategy.
It is important to note that the decision to shut down or continue operating will depend on various factors, such as the long-term viability of the business, market conditions, and the availability of alternative options. It is advisable to consider these factors and seek professional advice before making a final decision.