Say you are the manager of a perfectly competitive firm selling a t-shirts for restaurant advertisement. Your business is making a loss because total revenue is less than total costs. What would you do - shut down or continue to operate? Use hypothetical numbers to explain. Information you need to provide include - state the product you are selling, the price of the product, the quantity of the product you produce, fixed costs, total cost, figure out total revenue, total and average variable costs. Then go ahead and make your decision. Explain carefully why it makes better sense to shut down rather than continue to operate or to continue to operate rather than shut down, as the case may be. How do fixed costs play a role in your analysis? What is the difference between shutting down and going out of business?
Your business has fixed costs (e.g. rent) and variable costs (e.g. cloth). Your business should shut down if your average revenue is less than your average variable cost, i.e. if the price that you can sell one T-shirt for is less than the cost of making one T-shirt.
Fixed costs = $500 per month
Average variable costs = $10 per shirt
Current production = 100 shirts per month
Total variable cost = 100 x $10 = $1000
Total cost = $500 + $1000 = $1500
Price of one shirt = $5
Total revenue = 100 x $5 = $500
Profit = total ...
Using hypothetical numbers in the case of a t-shirt manufacturer, this solution shows how a firm makes the decision of whether or not to shut down production when it is making a loss. It also explains the difference between shutting down and going out of business.