CFA Practice Question

There are 539 practice questions for this study session.

CFA Practice Question

Beer and wine are the only goods produced in a perfectly competitive economy. Each is produced in a constant-cost industry and is currently in equilibrium. Suddenly there is a permanent shift in the preferences of consumers in favor of beer and away from wine.

As a wine producer, in the short run, your best strategy is to ______
A. keep operating as long as you can cover your average costs.
B. increase the price of your wine to compensate for decreased sales.
C. continue operating as long as you can cover your average variable costs.
Explanation: Producers in the wine industry will experience short run losses (the market price will be below average costs). As long as the firm can cover its variable costs, each sale will make some contribution toward reducing total losses. If the firm cannot cover its variable costs, then it will incur greater losses by operating the plant instead of shutting the plant down.

User Contributed Comments 5

User Comment
cbb1 If permanent, then shut-down is the best economic decision.
johnsk I suppose if you shutdown you still need to pay fixed costs (i.e. you cannot cancel your rent of the store). As long as you can cover your variable costs you should continue. A permanent shift of consumer preference is only one factor that determines demand: what if the total consumer base increases later? This may increase the number of people that drink wine even with the shift! So the best strategy is to continue and wait to see what happens next.
yanpz same thought here... I also believe if the preference is permanent, then we should shut down instead of covering variable cost.
oliver Preference is only one of many factors to decide your business' profitability. You should always look at the issue from variable versus fixed cost perspective. Therefore you should continue.
bobert In the short run you should ALWAYS continue to operate if you can cover your variable costs, because you can apply excess towards fixed costs. It is in the long run where you should shut down if market conditions (being the consumer preference in this questoin) do not look like they will improve. The word "permanently" I feel, would justify closing in the long run, but the question does indeed refer to short run.
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