9781118041581

Cost Analysis and Optimal Decisions 259

In sum, the firm should continue production because the product generates a

positive contribution, thereby minimizing the firm’s loss. The firm suffers an

economic loss in the short run; nevertheless, this is better than shutting down.

Thus, we have the following general rule:

In the short run, the firm should continue to produce as long as price exceeds

average variable cost. Assuming it does produce, the firm maximizes contribution

(and minimizes any losses) by setting marginal revenue equal to marginal cost.

In the long run, all inputs and all costs are variable. (For instance, a firm

that leases its plant and equipment can shed these costs if it chooses not to

renew its two-year lease. The firm can also downsize its workforce over time.)

In the long run, the firm should continue operating only if it expects to earn

a nonnegative economic profit. A firm that suffers persistent economic losses

will be forced to exit the industry.

Earlier we noted that the repair firm’s cost function is C  270 30Q .3Q^2. Suppose

demand is given by P 50 .2Q. What is the firm’s optimal course of action in the

short run? In the long run?

Multiple Products

In the previous section, we noted that the prevalence of multiproduct firms

is explained by economies of scope. The implication of such economies is

that the firm can produce multiple products at a total cost that is lower than

the sum of the items’ costs if they were produced separately. As we shall see,

managers must be careful to pay attention to relevant costs in a multiproduct

environment.

To illustrate, consider a firm that produces two products in a common

facility. The firm’s total cost of production is described as

where FC denotes the total fixed costs shared by the products. The separate

variable costs for the products also are included and depend directly on the out-

put levels of each product. The firm’s total profit is

[6.6]

where R 1 and R 2 denote the products’ revenues. As noted earlier, each term in

parentheses is the product’s contribution. The firm’s total profit is the sum of

its products’ contributions minus its total fixed costs.

(R 1 VC 1 )(R 2 VC 2 )FC,

CFCVC 1 VC 2 ,

CHECK

STATION 4

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