Answer the following questions: Why would a firm choose to operate at a loss in

Question

Answer the following questions:

Why would a firm choose to operate at a loss in the short run? Explain carefully.

A profit-maximizing business incurs an economic loss of $10,000 per year. Its fixed cost is $15,000 per year. Should it produce or shut down in the short run? Should it stay in the industry or exit in the long run? Suppose instead that this business has a fixed cost of $6,000 per year. Should it produce or shut down in the short run? Should it stay in the industry or exit in the long run?

(a multi-part question)

Explanation / Answer

The firm choose to operate in the short run becuase in the short run there is a fixed cost which is incurred irrespective of the fact that it operates or not. If the firm is able to cover variable cost, it operates in the short run.

Now if the firm shuts down, it will still have to pay 15000 and if it operates it will incur a loss of 10000 which is lower than 15000. Thus it should operate in the short run. In the long run there is no fixed cost and it shuts down it will have to pay 0 and it operates it will incur loss. Therefore it should exit in the long run.

Now when fixed cost is 6000 which is lower than loss of 10000, it should shut down in the short run. By shutting down it will pay 6000 only.

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