(8th edition) (the pearson series in economics) robert pindyck, daniel rubinfeld microecon 315

290 PART 2 • 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 do 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 7 (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 do 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 2 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.