South-Western College Publishing - Economics  
Web Woes
Subject Profits and losses, Shut-down condition
Topic Production and costs
Key Words Internet companies, salaries, stock options, NASDAQ, investors, initial public offering, businesses, downsize, layoffs
News Story

Many people have been tempted to join Internet companies by high salaries, the promise of stock options, and fantasies of early retirement. Unfortunately for some, their dreams have been shattered.

Some Internet businesses were damaged by the April 14 tumble of the NASDAQ which signaled that investors were no longer willing to pour money into dot-coms that were not profitable. With poorer prospects of a successful and speedy initial public offering, such businesses had to redefine their plans. Some had to downsize as they focused on their core businesses; others were obliged to close.

Employees were faced with layoffs. For example, drkoop.com Inc., a healthcare web site, laid off 50 (35 percent) of its employees. Toysmart.com, a Disney-backed retailer, was forced to shut down and terminate its 170 employees. Still, many Internet companies are thriving and the laid-off employees should be able to find other jobs, particularly given their skills.

(Updated August 1, 2000)

Questions
1. Draw a diagram of an Internet company such as drkoop.com Inc. with axes representing dollars and output. Add curves representing marginal cost, average total cost, and average variable cost, and a horizontal price line such that the firm is covering average variable cost, but not average total cost.
  a) Show the equilibrium price and output levels. Shade in the area representing the loss.
  b) Can the Internet firm stay open in the short run? Explain.
  c) Why can the firm not keep on making losses? Refer to economic theory and to the news story.
  d) How would layoffs help the company?
2. In a second diagram, draw the curves of a company like toysmart.com. Show the price line below the average variable cost curve.
  a) Show the short-run equilibrium position of the company.
  b) Can the firm stay open in the short run? Explain your answer.
3. Now draw a third diagram, this time showing the cost curves and the price line such that the Internet company is making a profit.
  a) Mark the equilibrium price and output. Shade in the area representing profits.
  b) Can the firm stay open in the short run? In the long run? Explain.
Source Matt Richtel, "www.layoffs.com: Internet Work Force Has Its First Brush With Downsizing," The New York Times, June 22, 2000.

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