you’re a soybean farmer. your annual fixed costs are 200k. It always costs you 5 USD to produce a bushel of soybeans, and you can do 125,000 bushels per year. The price of soybeans (market value) are $5,35/bushel for the next 2 years and then it will go to $7/bushel after 2 years.
What should you do?
A) continue as normal
B) go to 50% production for 2 years, then go back full 100% when the price hits 7
c) shut down for 2 years, and then reopen in 2 years
I tried to pick C b/c my math shows that TC>total revenue for the first 2 years, and Total Revenue > Total Cost after 2 years.
In forming my answer, I assumed that C (shutting down the operation) meant zero fixed costs. Was that right or wrong?
In the short run, a firm should operate as long as it, at a minimum, covers its variable costs. This condition is met since the sales price of 5.35/bushel is greater than the vaiable cost of 5.0/bushel. This is not viable in the long-run, if a firm can’t cover its variable and fixed costs. This means that 0.35 can go to covering fixed costs, 0.35x125,000 = 43,750 < 200,000. After two years, the portion to cover fixed costs = 7 - 5 = 2; 2x125,000 = 250,000… hence the firm should continue as normal.
Fixed costs could equal loan payments on property & equipment, insurance, property taxes, etc… Shutting down wouldn’t necessarily get rid of all these payments unless the property and equipment were sold. But, in two years, once it becomes profitable again, the farmer would have to go and buy all new equipment, land, etc…
Wrong.
You have a three-year lease on the warehouses in which you store the harvested soybeans, a five-year lease on your brand-new John Deere harvesting combines, and a two-year non-cancellable Verizon wireless plan.
Grow some soybeans, sell 'em, cover at least part of your fixed costs.