Question

Have you ever walked into a restaurant for lunch and found it almost empty? Why, you might ask, does the restaurant even bother to stay open? It might seem that the revenue from so few customers could possible cover the cost of running the restaurant. Provide an opinion using the concepts of sunk costs, marginal cost and marginal revenue.

Answer 1

A firm meets its zero profit point when the average total cost of production is equal to marginal cost . At this point the firm is being able to cover all its costs but does not make any profit .

After this we come to the loss zone where marginal cost ( price ) is below average total cost but above the average variable costs . Here the average or marginal revenue earned barely meets the variable costs but is not able to cover all the costs ( fixed costs ) . The firm is facing loss but still continues to operate in this shut down zone .

Now a sunk cost is a cost that a firm has incurred, and which can no longer be recovered . Sunk costs should not be considered when making the decision to continue investing in an ongoing project, since these costs cannot be recovered . So whether to run the restaurant or not does not depend on sunk costs .

The restaurant continues to operate till it reaches the shut down point where the marginal cost or marginal revenue earned is equal to or below average variable cost .