Break Even and Shut Down Analysis

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A firm currently uses 50,000 workers to produce 200,000 units of output per day. The daily wage per worker is $80, and the price of the firm’s output is $25. The cost of other variable inputs is $400,000 per day. Assume that total fixed cost equals $1,000,000. Calculate the values for the following four formulas:Total Variable Cost = (Number of Workers x Worker’s Daily Wage) + Other Variable Costs

TVC= (50,000 x 80) + 400,000

TVC= $[4,000,000 + 400,000]

TVC = $4,400,000Average Variable Cost = Total Variable Cost / Units of Output per Day

AVC= TVC/Q

But Q = 200,000

AVC = $(4,400,000/200,000)

AVC = $22.0Average Total Cost = (Total Variable Cost +Total Fixed Cost) / Units of Output per Day

ATC = (TVC + TFC)/Q

ATC = $(4,400,000 + 1,000,000)/200,000

ATC = $27Worker Productivity = Units of Output per Day / Number of Workers 

WP = Q/L where Q = 200,000 and L = 50,000

WP = 200,000/50,000

WP = 4

Complete the Following: Calculate the firm’s profit or loss

Total Revenue – Total Costs = Profit

Profitability = TR-TC

But TR = PxQ while TC = TFC + TVC

TC = $5,400,000; TR = $(200,000×25) = TR = $5,000,000

Profit = $(5,000,000 – 5,400,000) = -$400,000

Hence, Loss = $400,000

Shut-down Analysis

Compare the firm’s output price and the calculated average variable cost and average total cost. Should the firm shut down immediately when the total fixed cost equals $1,000,000?

At TFC = $1,000,000, the firm is running at a loss since TC>TR, representing a loss of $400,000.

The Price, P = $25, Average Variable Costs (AVC) = $22.0

Since P > AVC (that is $25 >$22), the firm should therefore should not immediately shutdown, instead, it should continue to produce at this level of fixed costs.

With production the loss is $400,000

Or Fixed Costs minus (P-AVC)*Q = $1,000,000 – $600,000 = -$400,000

Without production or shutdown the loss is $1,000,000.

Since the shutdown loss is even more than the production loss ($1,000,000>$400,000), the firm should better produce at this level of fixed costs as opposed to shutting down (Froeb, 2014).

Break-Even Analysis

If the firm can operate at a loss in the short run, how many employees need to be laid off for the company to break even? (Assume that after layoffs, the remaining workers maintain output at 200,000 units per day.)

Break-even price: Pbe = ATCmin = $27

Break-even price: Pbe =Average Total Costmin,

Pbe= $27

Workers productivityOutput / number of workers = 200000 / 50000 = 4 units per dayTotal costs – $5.4 M 1M Fixed costat break even, TR = $5M = TCDecrease my total cost by $400,000Decreased in Workers = Decrease in TC/wage rate = $400,000 / $80 = 5000Labor force = 50,000 – 5,000 = 45000 workers

The company therefore will have to lay-off 5,000 workers, leaving 45,000 workers to produce the same quantity of output. Given a lower number of employees now working at the company, what is the change in worker productivity? 

Workers Productivity = 200000/45000= 4.44 unit per dayDecrease our TC by $2.4 MTVC with 50000 is $4.4 M$2,000,000 is cost$2,000,000/ $80 = 2500025000 workers to produce 200,000Workers productivity = 200,000/25,000TC = $7.4 MLoss of 2.4MDecrease my work for by 2.4M2.4M/ $80 = 30000Workers productivity has to change200000/20000 = 10 units per dayIt is not possible, cant fire enough people when you have a fixed cost at 3million to assure productivity.The change of workers is too largeNo shut down

Revenue and Cost Table

Cost/Revenue Amount ($)

Total Revenue $5,000,000

Fixed Costs $1,000,000

Variable Costs $4,400,000

Total Costs $5,400,000

Average Total Cost (ATC)  $27.00

Average Variable Cost (AVC) $22.00

References

Froeb, L. M. (2014). Managerial Economics: A Problem Solving Approach. Australia: South-Western Cengage Learning.

Froeb, L. M., & McCann, B. T. (2010). Managerial Economics: A Problem Solving Approach. Mason, OH: South-Western Cengage Learning.

Trivedi, M. L. (2002). Managerial Economics: Theory And Applications. New Delhi: McGraw-Hill.