Fixed Costs

• physical investment that can’t be undone
• and can’t be done quickly
• financed by debt--bonds or loans
• and by equity

A Story

Morning: take your own money and either

• buy a factory (that is built in the morning so it can be used in the afternoon) with your money plus a bank loan
• or put your money in the bank

Afternoon

• if you built, get PQ - VC(Q) - (loan plus interest on loan)
• else get (your money plus interest on your money)

Evening:

• spend the money you have on wine and bread and watch sunset as world ends.

NOTE: you can’t build the factory in the afternoon--it is fixed. And you can’t avoid debt payment if you built

Relation to Profits

• Economic Profits

  p = P Q - VC(Q) - (loan plus interest) - (your money plus interest)

  FC is (loan plus interest) + (your money plus interest)

• Business Profits

  is: P Q - VC(Q) - (loan plus interest)

  Zero economic profit is a normal business profit

• In the story if you build you consume p + (your money plus interest)

Long and Short Run.

• Day One: same as before but world does not end. Instead, factory crumbles at sun set.
• Day Two: same as day one.
• The Short Run is a day. Investment is fixed.
• The Long Run is beyond a day: investment is variable

Example:

• Morning day one. Build one plant.
• Afternoon day one. Have one plant and only one plant. Fixed
• Morning day two. Have no plants. Build as many as you like, including zero.

Bankrupcy

• Bankruptcy happens when you can't pay your bills.
• It is a legal proceeding to enable to company to reorganize itself and continue operating.
• If p q < VC(q) you are surely bankrupt. You can not pay your suppliers or your laborers.
• If VC(q) < p q < C(q), you can pay your laborers and suppliers, but can not pay back all your fixed costs
• If you can’t pay your bank loans, you are bankrupt
• If you can, your are not bankrupt. However, you will not be able to pay yourself back for the money you invested in your business.

A True Story

There once was a beer distributor that came upon hard times and accused another beer distributor of doing illegal things to ruin its business. An economist was consulted and reasoned as follows: The amount of money the beer distributor was making was not its profits. Two things were missing: the building was owned by the owners of the business and could be rented instead of being used for the distributorship. the owner and his family could work somewhere else, so their wages should be deducted from the companies profits. When one made these adjustments it appeared that the distributorship was worth nothing even before the competitor arrived on the scene. I personally know of two more essentially identical stories, one involving a small pharmeceutical company and another a furniture factory.