5. Ball Bearings, Inc. faces costs of production as follows: Total Variable Cost

Question

5. Ball Bearings, Inc. faces costs of production as follows: Total Variable Costs $O 50 70 90 140 200 360 Total Fixed Costs Quantity 0 $100 100 100 100 100 100 100 2 5 b. The price of a case of ball bearings is $50. Seeing that he can't make a profit, the chief executive officer (CEO) decides to shut down operations. What is the firm's profit/loss? Was this a wise decision? Explain. c. Vaguely remembering his introductory economics course, the chief financial officer tells the CEO it is better to produce 1 case of ball bearings, because marginal revenue equals marginal cost at that quantity. What is the firm's profit/loss at that level of production? Was this the best decision? Explain.

Explanation / Answer

b)

Shut down point comes where price falls below the Average variable cost. Firm can bear fixed cost in short run but it can not bear the loss of variable factors. It will shutdown output if price falls below average variable cost.

This was not wise decision. By producing 1 units firms would be able recover variable cost fully.

c)

Yes, this wise decision. Firm is recovering variable cost here.

Profit = TR – TC

TR = 50 *1

TC = TVC +FC

TVC = 50*1

FC = 100

Profit = 50 – 50 – 100

       = - $100

        Firm incurring loss equal to $ 100 but fully recovering its variable cost of production. Hence firm must continue to produce.

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