Question

Question 13 1 pts You run a ginger beer factory. Market research suggests a price of $8/bottle will produce the highest revenue. You run production with this level of operating leverage. B: Fixed cost - 500 per month, Variable cost = $2/bottle Now, a new competing firm enters the market, pricing their ginger beer at $4 per bottle. You can sell as much as you like at that price but can no longer sell any at the higher price what is the shut down decision in the short run and long run? shut down; shut down open; shut down open; open shut down; open

Answer 1

In the question, it is given that firm 1 has,

Fixed cost = 500 / month; Variable cost = $ 2/ bottle.

Firm 1 can make a maximum profit if he sells his product at $8/bottle.(But not necessary that he will sell at this price. It is just an estimation)

Now the firm 2 enters into a market that is selling his product at $4/bottle.

• After the entry of firm 2, the condition of selling price changed.
• New Condition: The Maximum Selling price can be $4/bottle. None of the firms can sell at prices higher than this price.

Now the question is asking about the shutdown decision for firm 1 in short-run and long-run:

Short-run Scenario:

Shut down condition is: Total Revenue < Total Variable cost

Explanation:

If the firm's revenue (which it is earning by selling ginger beer bottles) is less than the variable cost(cost of production of beer), then obviously the firm will go into loss. It will lead to shut down of the firm.

Our Case:

In our case, the revenue of the firm is $4/ bottle.

The variable cost associated with production is $2/ bottle.

Revenue($4/bottle) > Variable Cost($2/bottle). Hence the firm will make profit.

Since the firm is making a profit there is no need for the firm to get shut down. Hence the firm will stay open in the Short-run.

Long-run Scenario:

Shut Down condition is: Revenue < Average Total Cost(ATC)

• Average Total Cost = (Fixed cost + variable cost)/ No. of quantities produced
• Ex. let's suppose in a month firm 1 is producing 500 bottles of beer. Hence its average total cost will be
• Average total cost = (Fixed cost(500) + variable cost(500*$2/bottle))/No. of units produced(500)
• Average total cost= (500+ 500*2)/500 = $3/bottle

From the above-mentioned example, it can be seen that if the company is producing 500 bottles of beer per month it will have an average total cost of $3/bottle.

In the question, it is given that we can sell as much as we like. So if we sell 500 bottles of beer per month, then the average total cost of 500 bottles of beer is less than the revenue.

Minimum no. of bottles company need to produce for remaining in profit, in the long run, is: (optional explanation for better understanding of the concept)

No. of bottles = 251( To calculate this use the above-mentioned formula and put ATC value = $4/bottle and take no. of bottles as an unknown function (x). after solving you will get no. of bottles = 250. At this value revenue = ATC. hence at 251 profits will start to occur)

Hence the company will still be making a profit if it sells more than 250 bottles/month. Therefore a company can remain open in the long run also.

Hence option C is the correct answer.