Question

Please write in sentence and explain clearly. Thank you,

Cathy started her own line of custom made, hand embellished wedding shoes. She opened up her own shop paid $2500 in fixed licensing fee. She used about $3000 in raw materials and made $3500. At the end of the first month, Carly, her sister looked at her financials and told her that she was losing money and should shut down. Cathy is heartbroken. As an economics guru, what would you advise her to do?

Answer 1

It is not advisable to shut down the business. In the question the license fees of $2500 is a fixed cost and will not be considered while taking shut down decisions. Because fixed cost cannot be avoided even if you stop the production. As long as the total revenue is more than the total variable cost, the business should continue production. So here the total revenue is $3500 and raw material (variable cost) is $3000. It means the business is eventually getting profits since it is recovering its variable cost. At this point if Cathy stops the production, then the loss will be equal to fixed cost ($2500).

Hence, it is not a good suggestion to stop the business.