Answer to Question #195928 in Macroeconomics for telmid ermias

Question

You've been hired by an unprofitable firm to determine whether it should shut down its operation. The firm currently uses 70 workers to produce 300 units of output per day. The daily wage (per worker) is 100 ETB, and the price of the firm's output is 30 ETB. The cost of other variable inputs is 500 ETB per day. Although you don't know the firm's fixed cost, you know that it is high enough that the firm's total costs exceed its total revenue. You

know that the marginal cost of the last unit is 30 ETB. Should the firm continue to operate at a loss? Carefully explain your answer.

Answer 1

The profit incurred by a firm is the excess of total revenue earned by the firm over the total cost incurred by the firm. When the profit is negative, the firm is said to incur losses. 

The firm is said to break even at the point where the average total cost is equal to the marginal cost of the good. This indicates that the firm is running at a normal profit, which is zero economic profit level. 

The shutdown point happens when the marginal cost is equal to the average variable cost. This implies that the firm cannot recover even the fixed cost by producing goods. The shutdown point is the point below which a firm should not operate. 

In the given case, the firm has an average variable cost to be 500 ETB. The marginal cost for the last unit is 30 ETB. Therefore, marginal cost is lower than the average variable cost. Hence, the firm is operating at a point above the shutdown point. Hence, the firm should continue with the operation of goods and services.