A friend owns a hotel that gets a lot of seasonal business. The average total cost per day of running the hotel is $75

A friend owns a hotel that gets a lot of seasonal business. The average total cost per day of running the hotel is $75. She tells you that during the off-season (when there are a lot of empty rooms), she had someone offer her $70 for a room. She indignantly tells you she turned the offer down since it was less than her average cost. Was that a good decision? Explain your answer in detail.

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Expert Solution

Ans) If price is above ATC, firms earn positive economic profit. If price is below ATC, firms earn negative economic profit but they will continue to produce as long as price is above AVC because it will minimise loss. And if price is below AVC, firm should shutdown because by continuing to produce, it will incur more loss.

Now, here, since ATC is $75 and price is $70, she could have minimized her loss by accepting that offer if the price were above AVC. So, assuming that price offered was above AVC, it wasn't wise to decline the offer.

In the graph, loss when produce means the loss when she would have accepted the offer. And loss when shutdown means the loss when she declined the offer.

Rahul Sunny answered 1 year ago

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