Question

what happens when a firm is hit with a new Licensing Fee that raises its fixed cost of operation significantly, but not does impact the variable cost or marginal cost.

• Which of the firm's costs will be impacted by the new licensing fee (AVC, ATC, MC)? Why?
• Will the new licensing fee change the firm's profit-maximizing (equilibrium) quantity? Why or why not?
• What should the firm's response be since it is still in the short run? What will determine whether a firm will continue operating or shut down? Explain.

Answer 1

In the question, it is mentioned that the firm is hit with a new Licensing Fee which has raised the fixed cost of operation significantly. However, there has been no impact on the variable cost or marginal cost. The new licensing fee will impact the firm's average total cost as the average total cost is the per unit total cost. The total cost is the summation of the total variable cost and total fixed cost. Thus, since new licensing fee is impacting the total fixed cost, it also affects the average total cost. The new licensing fee will not impact the average variable cost and marginal cost as they both are non-affected by the new licensing fee. The new licensing fee will not change the firm's profit maximizing equilibrium quantity. This is because, the firm's profit is maximized at a point where the marginal cost is equal to the marginal revenue. And in the question, it is mentioned that the marginal cost is not affected by the new licensing fee. Thus, the equilibrium output will change only if the company decides to change the price it intends to charge. The firm should focus on reviewing its pricing policy in the short run. The company should understand that though its marginal cost has not changed but its average total cost has changed as a result of the new licensing fee and should charge a higher price which would help in the survival in the long run. In the general cases the decision of continuing with the production or shutting down is decided by the fact if the company can cover its variable cost. But the company should also focus on the fact that their fixed cost has increased significantly and should decide accordingly.