Case study of firm incurring losses

• In mid 1980, Texas Instrument (TI) was selling its

basic home computer for $650. But cost reducing
technology and intense competition from firms
such as Atari, Commodore, and Tandy drove market
prices steadily downward.
• By mid 1982, TI had been forced to cut its price to $
249/- and by early 1983, the firms’ basic computer
could be purchased for just $ 149.
• Still, because the TI’s variable cost per unit was
about $ 100, the firm better off continuing to
produce, even at this low price
• But improved technology and competitive
pressures continued to push prices even lower.
By the fall of 1983, market conditions required
TI to reduce its price to $ 99. Because this level
was less than the $ 100 variable cost, the firm
stopped producing home computers. However,
at the time of shutdown decision, the company
had almost 500000 unsold computers on hand.
TI finally got out of the home computer
business by dumping its remaining inventory
onto the market at $ 49 per unit.
• If the variable cost of produing a computer was $ 100,
why would the firm be willing to sell its remaining
machines for less than that amount? The explanation is
that $ 100 was a variable cost before the computers
were produced, but a sunk cost afterward. Thus, the
firm was better off selling the computers than keeping
them as long as the $ 49 price was greater than the
transporation and marketing expenses of selling each
unit.
• TI was not alone in its exit from the home computer
market. Dozens of smaller companies also determined
that their losses would be less if they shut down than if
they continued to produce.
 Calculating the shutdown price
• A lamp manufacturer faces horizontal demand
curve. The firm’s total cost are given by the
equation
• TVC = 150Q – 20 Q2 + Q3
• Where Q is quantity. Below what price the
firm shut down its operations?
 Problems
• Suppose the market supply and demand
equations for plywood are given by
• Qs = 20000 + 30 P
• Qd = 40000 – 20 P
(a) Determine the equilibrium price and quantity?
(b) Suppose an increase in housing starts results
in a new demand equation
Qd1 = 50000 – 20 P what is the new
equilibrium price and quantity?
• 2. Use the above market demand and supply
schedules? The Plywood industry is perfectly
competititve, and the marginal cost equation
for one firm Lucknow Plywoods,is given by
MC = 200 + 4 Q
(a) What is the short run profit maximising
output rate for Lucknow plywoods?
(b) Average cost is given by AC = 1000/Q + 200 +
2Q. In the short run how much economic
profit will the firm earn?