Question

A firm claims on its website that it has been in the same location for over 50 years and has lower over- head than other firms because it bought the land 50 years ago when it was inexpensive. It also claims that it charges lower prices than competitors because of its lower overhead. Discuss the logic of these claims.

* this question needs an answer according to competition in the short run * the subject is economics. thanks

Answer 1

A firm claims on its website that it has been in the same location for over 50 years and has lower over- head than other firms because it bought the land 50 years ago when it was inexpensive. It also claims that it charges lower prices than competitors because of its lower overhead. Discuss the logic of these claims.

Answer-

Overhead Costs are fixed expenditures that you pay for office rent, utilities, telephone, wages etc. This is the cost borne by the firm to keep the business open and running even when there is no revenue generating activity.

In the given situation, the firm claims low overhead expenditure due to low cost of land ie rent. In the short run, the Fixed costs are sunk costs and should not be considered while taking any economic decision. So when the firm says its fixed costs are lower than the competition, it should not affect the price of the product as it is the Average total cost and Marginal Cost vis-a-vis the price, which decide the profitability of the product.

Having said that, in the long run the total cost of production does go down with low overheads creaing a larger profit margin thus the opportunity to lower the prices of the product.