Question

The economy is shrinking, firms with low operating leverage will experience

a.larger decreases in profits than firms with high operating leverage.
b.similar decreases in profits as firms with high operating leverage.]
c.smaller decreases in profits than firms with high operating leverage.
d.no change in profits.

Answer 1

Firms with low operating leverage will experience larger decreases in profits than firms with high operating leverage.

Step-by-step explanation:

Firms with low operating leverage will experience larger decreases in profits than firms with high operating leverage when the economy is shrinking. Operating leverage refers to the proportion of fixed costs to variable costs a firm has. Firms with low operating leverage have a higher proportion of variable costs, which can be adjusted more easily in response to changes in the economy. On the other hand, firms with high operating leverage have a higher proportion of fixed costs, which are more difficult to adjust.

For example, consider two firms: Firm A and Firm B. Firm A has low operating leverage and a higher proportion of variable costs. When the economy shrinks, Firm A can quickly adjust its variable costs by reducing production or cutting back on expenses, resulting in smaller decreases in profits. Firm B, on the other hand, has high operating leverage and a higher proportion of fixed costs. It may not be able to easily reduce its fixed costs, leading to larger decreases in profits.