The owner of an Italian restaurant has just been notified by her landlord that t

Question

The owner of an Italian restaurant has just been notified by her landlord that the monthly lease on the building in which the restaurant operates will increase by 20 percent at the beginning of the year. Her current prices are competitive with nearby restaurants of similar quality. However, she is now considering raising her prices by 20 percent to offset the increase in her monthly rent. Would you recommend that she raise prices?

a) No - the increase in lease expense is a marginal cost.

b) No - the increase in lease expense is a fixed cost.

c) Yes - the increase in lease expense is a fixed cost.

d) Yes - the increase in lease expense is a marginal cost.

Explanation / Answer

Answer - No - the increase in lease expense is a fixed cost.

Reason - the lease rent for the restaurant is a fixed cost, which means the cost of rent will continue to occur even if the owner of the restaurant stops serving customer in restaurant or increase the production to double. The fixed cost is not allocable to the cost of production directly. It is a sunk cost. The prices can't be increased due to increase in a fixed cost.

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