Ted has been a fisherman all of his life. Ted realizes the risk he takes as a bu
ID: 1219932 • Letter: T
Question
Ted has been a fisherman all of his life. Ted realizes the risk he takes as a business whose market structure is a perfectly competitive market. Ted is analyzing whether he should stay in business. He is fortunate that all of his nets, fishing gear are all paid for but Ted still has other fixed and variable costs that he incurs as a part of doing business.
Help Ted analyze his cost information and serve as his business consultant.
Here is some cost information that Ted has given you:
Fixed Costs are $50,000 per year. Insurance, dock space, and rental of fish processing equipment.
Total Total
Number of Fixed Variable
Fish Caught Costs Costs
1,000 50,000 $25,000
2,000 50,000 $40,000
3,000 50,000 $90,000
Questions
1. What is the lowest Average Total Cost that Ted can operate his business? In other words, at what cost do we reach the bottom of the average total cost curve?
2. At a market price of $51 per fish, what quantity does Ted process and what is the firm’s accounting profit at this output? (remember the profit maximization rule)
3. At a market price of $45 per fish, what quantity does Ted process and what is the firm’s accounting profit at this output?
4. Ted is now faced with more competition. The market price of fish has dropped $22 per fish. Should Ted stay in business or shut down his operation? Also, what quantity of fish should he process at this point, if applicable?
5. Based on the information given, what is Ted’s shutdown point in terms of price? In other words, what market price will force Ted to shut down his operation?
Explanation / Answer
Working notes:
(a) Total cost (TC) = Total fixed cost (TFC) + Total variable cost (TVC)
(b) Average total cost (ATC) = TC / Q
(c) Profit is maximized when P = MC, where
(d) MC = Change in TC / Change in Q
(e) Accounting profit = Q x (P - ATC)
(f) Shut-down point is where P = AVC, where
(g) AVC = TVC / Q
Following data table is to be used.
(1) ATC is lowest at $45.
(2) When P = $51, closest value of MC is $50 when Q = 3,000.
Profit = 3,000 x $(51 - 47) = 3,000 x $4 = $12,000
(3) When P = $45, closest value of MC is $50 when Q = 3,000.
Profit = 3,000 x $(45 - 47) = 3,000 x (- $2) = - $6,000 (Loss)
(4) When P = $22, lowest ATC is higher than price, therefore there is a loss even in the short run since revenues cannot cover total variable cost. So firm should shut down.
Note: First 4 questions are answered.
Q TFC TVC TC AVC ATC MC 1,000 50,000 25,000 75,000 25 75 75 2,000 50,000 40,000 90,000 20 45 15 3,000 50,000 90,000 1,40,000 30 47 50Related Questions
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