Answer to Question #53084 in Economics for Clarabelle

Question

At a recent board meeting, the president and CEO got into a heated argument about whether to shut down the firm’s plan in Miami. The Miami plant currently loses $60,000 monthly. The president of the firm argued that the Miami plant should continue to operate, at least until a buyer is found for the production facility. The president’s argument was based on the fact that the Miami plant’s fixed costs are $68,000 per month. The CEO exploded over this point, castigating the president for considering fixed costs in making the shutdown decision. According to the CEO, “Everyone knows fixed costs don’t matter!”
a. Should the Miami plant be closed or continue to operate at a loss in the short run?
b. How would you explain to the incorrect party that he is wrong?

Answer 1

Loses $60,000 monthly. Fixed costs FC = $68,000 per month.
a. It is impossible to say clearly if Miami plant should be closed or should continue to operate at a loss in the short run, because we should compare price (P) and average variable costs (AVC) to consider the necessity of the shutting down. The firm will be closed in the short-run, if P < AVC.
b. We need to explain to the incorrect party that it is incorrect to compare losses and fixed costs of the firm to consider the necessity of closing the firm.