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Chapter 20: Problem 1

\(\mathrm{Al}\) and George's used car lot has total revenue of \(\$ 5\) million, fixed costs of \(\$ 8\) million, and variable costs of \(\$ 4\) million. In the short run the firm will__________ and in the long run it will \((\mathrm{LO8})\)__________ a) shut down, go out of business b) shut down, stay in business c) operate, stay in business d) operate, go out of business

Short Answer

Expert verified
In the short run, Al and George's used car lot will operate, and in the long run, they will go out of business.

Step by step solution

01

Calculate Total Costs

To calculate the total costs, we need to combine the fixed and variable costs: Total Costs = Fixed Costs + Variable Costs = \(8 million + \)4 million = $12 million
02

Compare Total Revenue with Total Costs

Now, we need to compare the total revenue with the total costs: Total Revenue = $5 million Total Costs = $12 million In this case, our total costs exceed the total revenue.
03

Determine Short Run Action

In the short run, a business should continue to operate if it can cover its variable costs, since the fixed costs have already been incurred and cannot be recovered. Let's compare the total revenue with the variable costs: Total Revenue = $5 million Variable Costs = $4 million Since the total revenue can cover the variable costs (\(5 million > \)4 million), the car lot should continue to operate in the short run.
04

Determine Long Run Action

In the long run, a business should continue to operate if it can cover both its fixed and variable costs with the generated revenue. We've already established that the Total Costs exceed the Total Revenue (\(12 million > \)5 million). This means that Al and George's used car lot cannot cover both fixed and variable costs in the long run. Using the analysis in Step 3 and Step 4, we can now select the correct answer from the given options: a) shut down, go out of business b) shut down, stay in business c) operate, stay in business d) operate, go out of business The correct answer is: (d) operate, go out of business.

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Most popular questions from this chapter

Which of the following is most likely to be a variable cost? (LO1) a) Real estate taxes b) Rental payments of IBM equipment c) Interest on bonded indebtedness d) Fuel and power payments

When \(\mathrm{MC}\) is rising but still below ATC, then __________ ( LO5) a) ATC is declining b) ATC is constant c) ATC is rising d) there is no way of determining what ATC is doing

Each of the following provides an example of economies of scale except __________ ( LO7) a) the computer software industry b) the pharmaceutical industry c) Adam Smith's pin factory d) movie and TV production e) the services of psychiatrists, personal trainers, barbers, and beauticians

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The decision to shut down is made in __________ (LO8) a) both the short run and the long run b) neither the short run nor the long run c) the long run d) the short run
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