Answer to Question #194530 in Microeconomics for shabbir

Question

a.      The chief financial officer tells the CEO that it’s better to produce only one shoe this month. What could be the reason for this advice by the CFO? What are the firm’s profits at that level of production? Is this the best decision? Explain. (1 Mark)

Answer 1

Assuming the fixed costs are $100 and the price of ABC shoe is $50

(a) The price of charged by the firm ABC is $50. It is profitable to produce more output when the price is greater than the average cost. 

The average total cost (ATC) which is calculated by dividing the total cost by quantity, is greater than the price charged for all the output level. 

We can see from the table that, the price is lower than the average total cost at each level of quantity. This shows that, it is not profitable to produce in the short-run.

In the short-run, the firm will only produce when the price is greater than or equal to average variable cost (AVC) of production. If the price becomes less than the AVC, this means that the firm cannot even able to cover its cost of variable factor and thus, it should shut-down in the short-run. 

Thus, according to this shut-down rule, the firm should only produce 1 quantity, where the AVC is 50 and equal to the price level which is advised by the CEO. 

The profits at this quantity level would be,

Profits =Total revenue − Total cost

$= (50×1) − (150)$

$=−100$

Profits = Total revenue - Total cost= (50×1) - (150)= -100

This means the firm will only cover cost of variable factor and incur the loss equal to the fixed cost, 100. 

Yes, this is the best decision according to the CEO which is based on the economic principles.