Supports: Econ (Chapter 12 – Firms in Perfectly Competitive Markets (Section 12.4); Essentials: Chapter 9 (Section 9.4)
Solved Problem: When to Re-Open Disney World during a Pandemic
In mid-March 2020, during the Covid-19 pandemic, the Walt Disney Company closed its Walt Disney World theme park in Orlando, Florida. In late May, the company announced that with the approval of the Florida government it would reopen Disney World in mid-July. An article in the Wall Street Journal noted that the company’s costs would increase because employees would need to reduce the likelihood of visitors contracting the virus while in the park by taking measures such as additional cleaning of the parks and checking the temperatures of customers. At the same time, the company’s revenue would likely fall because fewer people were expected to buy tickets to the park or to stay in the company’s hotels. When asked about these issues, Disney CEO Bob Chapek stated that, “We would not open up until we could cover our variable costs ….” If Disney covers its variable costs of operating Disney World, can the company be certain that it will earn an economic profit? If not, why would the company open the park?
Source: Erich Schwartzel, “Disney World to Reopen Gradually Starting July,” Wall Street Journal, May 27, 2020.
Solving the Problem
Step 1: Review the chapter material. This problem is about the break-even price for a firm in the short run and in the long run, so you may want to review Chapter 12, Section 12.4 “Deciding Whether to Produce or to Shut Down in the Short Run.”
Step 2: Answer the first question by explaining the circumstances under which a firm earns an economic profit. To earn an economic profit, a firm’s revenue must be greater than all of its costs—both its fixed costs and its variable costs. So, Disney covering its variable costs is not enough for the company to earn an economic profit if it is not also covering its fixed cost.
Step 3: Answer the second question by explaining why Disney is better off opening Disney World even if it is only covering its variable cost. With the park closed, Disney is earning no revenue but still has to pay the fixed costs of the park. These fixed costs include the opportunity cost of the funds the company’s shareholders have invested in the park, fire and other insurance premiums, and the cost of the electricity necessary to power lights and security systems. If the park remains closed, Disney will suffer an economic loss equal to its fixed cost. If the park is opened and Disney earns enough revenue to cover the variable costs of operating the park—including the salaries of employees operating rides and working in restaurants, the higher utility costs, and the costs of increased cleaning necessitated by the virus—Disney will reduce its loss to an amount smaller than the value of its fixed costs, even though the company will not be earning an economic profit. In this circumstance, Disney will be better off opening the park than keeping it closed. In general, as we’ve seen in the chapter, firms will be willing to operate in the short run if they can earn revenue at least equal to their variable costs. Note, though, that in the long run, Disney would need to cover all of its costs of operating the park to keep it open.