● A firm that shuts down temporarily still has to pay its fixed costs. Exit: refers to a long-run decision to leave the market ● A firm that exits the market does not have to pay any costs at all, fixed or variable. Ex: A farmer who faces a fixed cost, the farmer’s land. If the farmer decides not to produce any crop s one season, the land lies fallow, and he cannot recover this cost. When making the short-run decision whether to shut down for a season, the fixed cost of land is said to be a sunk cost . By contrast, if the farmer decides to leave farming altogether, he can sell the land. When making long-run decision whether to exit the market, the cost of land is not sunk . **the firms shuts down if the revenue that it would earn from producing is less than its variable cost of production. TR = Total Revenue VC = Variable Costs Shuts down if TR < VC The firm shuts down if total revenue is less than variable cost. By dividing both sides of this inequality Q, we can write it as: Shuts down it TR/Q < VC/Q The left side of the inequality, TR/Q, is total revenue P x Q divided by quantity Q, which is average revenue, most simply expressed as the good’s price, P. The right side of the inequality, VC/Q, is average variable cost, AVC. Therefore, the firm’s shutdown criterion can be restated as: Shut down if P < AVC The Competitive Firm’s Short-Run Supply Curve (Pg. 287) [Figure.3] In the short run, the competitive firm’s supply curve is its marginal-cost curve (MC) above average variable cost (AVC). If the price falls below average variable cost, the firm is better off shutting down. · When choosing to produce, the firm compares the price it receives for the typical unit to the average variable cost that it must incur to produce the typical unit. · If price doesn’t cover the average variable cost, the firm is better off stopping production altogether. · The firm still loses money (b/c it has to pay fixed costs), but it would lose even more money by staying open. · The firm can reopen in the future if conditions change so that price exceeds average variable cost. **the competitive firm’s short-run supply curve is the portion of its marginal-cost curve that lies above average variable cost.
Split Milk and Other Sunk Costs Sunk: a cost that has already been committed and cannot be recovered. · We assume that the firm cannot recover its fixed costs by temporarily stopping production. Regardless of the quantity of output supplied (even if it’s zero), the firm still has to pay its fixed costs. Ex: imagine you place a $15 value on seeing a new movie. You buy the ticket for $10, but then you lost your ticket before going into the theatre. Should you buy another ticket? Or should you go home and refuse to pat a total of $20 to see the movie. The answer is that you should buy another ticket. The benefit of seeing the movie ($15) still exceeds the opportunity cost ($10 for the second ticket). The $10 you paid for the lost ticket is a sunk lost.