Scenario 9.1: 21st Century Pen, Inc. produces 2,000 pens per day, and hires 20 workers at a cost of $200 per day per worker. The price of each pen is $5 each. 21st Century Pen, Inc. pays a daily rental rate of $60 on its factory and a daily insurance rate of $20. 21st Century Pen, Inc. has a ten year lease on the factory, an insurance contract for a year, and the company has no other expenses.
-Refer to Scenario 9.1.Suppose that 21st Century Pen,Inc.continues to produce the same level of output and hires the same number of workers.21st Century Pen,Inc.will shut down in the short run if the price falls below

Question

Quizplus · Accepted Answer

In the short run, a firm will shut down if the price falls below its average variable cost (AVC). The variable costs here are the costs of labor ($200 per worker per day for 20 workers = $4,000). The fixed costs (rental rate of $60 and insurance rate of $20, totaling $80) are not considered in the calculation of AVC because they are incurred regardless of the level of production. The AVC can be calculated as the total variable costs divided by the quantity of output, which is $4,000 / 2,000 pens = $2 per pen. Therefore, if the price falls below $2, the firm will not be able to cover its variable costs and will shut down in the short run.