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290 PART • Producers, Consumers, and Competitive Markets Remember from §7.1 that a fixed cost is an ongoing cost that does not change with the level of output but is eliminated if the firm shuts down fixed costs not change with the level of output, but they can be eliminated if the firm shuts down (Examples of fixed costs include the salaries of plant managers and security personnel, and the electricity to keep the lights and heat running.) Will shutting down always be the sensible strategy? Not necessarily The firm might operate at a loss in the short run because it expects to become profitable again in the future, when the price of its product increases or the cost of production falls Operating at a loss might be painful, but it will keep open the prospect of better times in the future Moreover, by staying in business, the firm retains the flexibility to change the amount of capital that it uses and thereby reduce its average total cost This alternative seems particularly appealing if the price of the product is greater than the average variable cost of production, since operating at q* will allow the firm to cover a portion of its fixed costs Our example of a pizzeria in Chapter (Example 7.2) provides a useful illustration Recall that pizzerias have high fixed costs (the rent that must be paid, the pizza ovens, and so on) and low variable costs (the ingredients and perhaps some employee wages) Suppose the price that the pizzeria is charging its customers is below the average total cost of production.Then the pizzeria is losing money by continuing to sell pizzas and it should shut down if it expects business conditions to remain unchanged in the future But, should the owner sell the store and go out of business? Not necessarily; that decision depends on the owner’s expectation as to how the pizza business will fare in the future Perhaps adding jalapeno peppers, raising the price, and advertising the new spicy pizzas will the trick E XA MPLE 8.2 THE SHORT-RUN OUTPUT DECISION OF AN ALUMINUM SMELTING PLANT How should the manager of an aluminum smelting plant determine the plant’s profit-maximizing output? Recall from Example 7.3 (page 240) that the smelting plant’s short-run marginal cost of production depends on whether it is running two or three shifts per day As shown in Figure 8.5, marginal cost is $1140 per ton for output levels up to 600 tons per day and $1300 per ton for output levels between 600 and 900 tons per day Suppose that the price of aluminum is initially P1 ϭ $1250 per ton In that case, the profit-maximizing output is 600 tons; the firm can make a profit above its variable cost of $110 per ton by employing workers for two shifts a day Running a third shift would involve overtime, and the price of the aluminum is insufficient to make the added production profitable Suppose, however, that the price of aluminum were to increase to P ϭ $1360 per ton This price is greater than the $1300 marginal cost of the third shift, making it profitable to increase output to 900 tons per day Finally, suppose the price drops to only $1100 per ton In this case, the firm should stop producing, but it should probably stay in business By taking this step, it could resume producing in the future should the price increase
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