Give an example of a firm that cannot cover total costs but decides to remain open even so. Use hypothetical numbers and avoid using any examples provided in the text.

Question

What will be an ideal response?

Answer 1

but should show a thorough understanding of why a firm would stay open when it can’t cover total costs. For example, a shop owner who sells T-shirts in Florida is dealing with low sales because of severe weather conditions, including hurricanes. In August and September, he usually sells about 250 shirts per month at about $25 per shirt, bringing in $6,250. His monthly fixed costs, including rents and insurance, are $1,000 per month and his average variable costs are $3,500 per month, making his average total cost $4,500 per month. However, in August his sales dropped to 175 T-shirts, and in September sales dropped further to 150 T-shirts. However, he brings in enough to cover his variable costs and part of his fixed costs, so the situation is better economically than if he shut down and still had to pay the fixed costs. So he decides to stay open, hoping that the weather will improve and his sales will return to normal.