Question

1. Ajax is a competitive firm operating under the following conditions: Price of output is $5, the profit-maximizing level of output is 20,000 units of output, and the total cost (full economic cost) of producing 20,000 units is $120,000. The firm’s only fixed factor of production is a $300,000 stock of capital (a building). If the interest rate available on comparable risks is 10 percent, should this firm shut down immediately in the short run? Explain your answer

Answer 1

The decision for the firm to shut down is based on whether the total revenue is greater then the total variable cost.

The total revenue is:

$$TR = \$5\times 20,000 = \$100,000$$

The firm's total cost is:

$$TC = \$120,000$$

The cost of capital is $10\%$ and the stock is worth $\$300,000$ . Thus, the fixed cost is:

$$FC = 10\%\times \$300,000 = \$30,000$$

This means that the variable cost is equal to:

$$VC = \$120,000 - \$30,000 = \$90,000$$

Since the firm's total revenue is more than its variable costs, the firm should not shut down in the short run.