Final answer:
With decreasing purchase prices, FIFO yields lower COGS and potentially higher net income. However, if prices drop enough to make total costs exceed total revenues at all output levels, the firm will face losses and will aim to minimize them by finding an output level where the revenue-cost gap is smallest.
Step-by-step explanation:
With decreasing purchase prices, FIFO (First In, First Out) yields lower costs of goods sold (COGS) compared to other inventory accounting methods like LIFO (Last In, First Out), because the costs recorded are associated with the oldest inventory, which was purchased at the higher cost reflective of the past price.
In a period of decreasing prices, the older, higher-cost inventory remains on the balance sheet as assets, while the cost of goods sold reflects the more recent, lower-cost purchases. This can result in a higher net income since the lower COGS under FIFO will minimize the gap between total revenue and total costs.
However, if the purchase price decreases enough, a company may find that at every level of output, total costs are higher than total revenues, leading to losses. Under such circumstances, a profit-maximizing firm will seek to produce at the quantity where the difference between total revenues and total costs is smallest, thus minimizing losses.