Should your restaurant shut down?

Intended for a microeconomics course under the topic costs of production. Prior to the activity students should have studied the definitions of fixed, sunk, variable, implicit and explicit costs including the relevance of opportunity cost for one's time.

The activity will take 10 - 15 minutes for small groups (unlimited in number) to reach a decision and 15 - 20 minutes for reporting their decision and follow-on direct instruction.

Overview

Students apply their understanding of fixed (sunk), variable, explicit and implicit costs to determine if a business, in this case a restaurant, should shutdown prior to exiting the market. Students are given data and need to determine which costs are relevant to the decision, omitting sunk costs and determining a reasonable implicit cost of the owner's time that is not specified in the problem.

The options include shutting down for two possible reasons (a loss or low profits) and not shutting down with two options (continuing as usual or using only the owner's labor.) The choices prompt discussion of when sunk costs are relevant and what is a reasonable estimate to value the owner's time and how it should be applied in decision-making.

Expected Student Learning Outcomes

Students will learn to apply the concepts of sunk costs and implicit costs in a realistic business decision.

Information Given to Students

Should you shutdown the restaurant.docx (Microsoft Word 2007 (.docx) 14kB Jun21 19)

You are the owner of a restaurant that is falling on hard times. You need to close it down next week but question remains:

Should you stay open this weekend?

Here are your cost considerations.

· Rent for the month paid already $2000

· Time you already spent preparing the weekend's menu and hiring schedule 10 hours

· Time you will spend this weekend opening and closing the restaurant 20 hours

· Cost of food and utilities for the kitchen this weekend $600

· Cost of staff for the weekend $700

· Total revenue you expect to receive for the weekend after taxes $1700

Do you:

A) Not open for the weekend because you will be operating with a loss

B) Not open for the weekend because you will have a profit that is positive but too small

C) Open for the weekend as usual

D) Open for the weekend but not hire any staff and run the restaurant as best you can with your own labor

When teams have voted on their decision, differences should be debated between teams, initially without instructor intervention. At a later point, the instructor may want to ask teams to be explicit in their use of terms studied in this unit: sunk costs, explicit costs, implicit costs, opportunity costs. Note that sunk fixed cots include rent and owner's time spent beforehand. Implicit costs include the owner's time. Explicit costs are rent, food and utilities, and staff. Total variable costs are $1300 + value of owner's time.

Different decisions will depend on the dollar value assigned to the owner's time. While there are reasonable values, likely at least $15 and no more than $100, the problem itself hinges on whether the chosen value is greater or less than $20.

Students may have questions about the exit decision that is assumed in the problem.

Certainly it is reasonable for teams to suggest ways to avoid exit altogether through efforts such as advertising, new menu and so on. Such commentary is legitimate and should be recognized as relevant. The instructor could suggest that we set aside these ideas for the moment and focus on the immediate shutdown decision, returning later to the creative solutions.

Teams may vote for the restaurant to stay open even if it is not loss minimizing for two reasons::

1) in the long run it may be best to maintain relationships with customers, vendors and employees. If the restaurant can be restored to profitability or if the owner wants to open a new restaurant, she will will need be in good stead with customers, vendors and employees. Staying open for the weekend could foster such good relationships.

2) Even if it isn't profitable in the short or long run, business owners can have other motivations. In this case, the owner may feel an ethical responsibility to employees to maintain their pay over the weekend. The decisions raises questions about profit-maximization as the only goal for businesses, an issue applicable to corporations as well see The Shareholder Value Myth: How Putting Shareholders First Harms Investors, Corporations, and the Public.

If the $16.66 threshold does not come up during team discussion, a follow-on activity for teams or individuals would be to determine the minimum value the owner needs to assign to time to cause the owner to shut down (that is $20).