In considering whether to stay open or shut down in the short run, a firm compares its revenues to its “avoidable costs”. We usually think of these avoidable costs as variable costs, but of course they could be fixed. This is where I have a thought experiment question:
Suppose we are looking at profit over a month. It is negative. You are considering if you are at least covering avoidable costs. How do we consider capital cost?
Case 1: You rent the factory and the lease is not flexible. This is a sunk cost.
Case 2: You own the factory. Your best alternative is to rent your factory out. If you shut down, you can easily find a replacement (assume no transaction cost). Then this foregone rent is an avoidable cost.
Case 3: This is where it gets tricky for me. You own the factory and no rental market exists. However, you can easily sell the factory if you shut down. So in my mind this is avoidable and the foregone rent (user cost of capital) is the relevant cost. But this doesn’t consider future profits unless we assume that the firm can buy back the factory in the following period when/if prices rise again. This seems incorrect.
That seems to be a downfall of static maximization. How would you propose thinking about this last scenario? Why don’t we consider dynamic profits when discussing shut down decisions?