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

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

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

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

Answer 1

The correct answer is (b) No - the increase in lease expense is a fixed cost.

Now her rent increased by 20% and the cost of producing or making food in the restaurant is independent of Monthly rent and hence, monthly rent is independent of amount of output produced.. Hence, this monthly rent is a Fixed cost because Fixed cost represents that portion of cost which is independent of output

In order to maximize profit a firm produces that quantity at which P = MC and MC is independent of Fixed cost. Hence MC remains same, So she will produce previous amount of quantity and hence will charge same price.

It is given that her restaurant prices are perfect competitive and hence it is a price taking firm and every restaurant is charging a same price and hence if it will increases the price then consumer will shift from her restaurant to others.

Hence, No i would recommend her to charge same price because it is just a Fixed cost.

Hence, The correct answer is (b) No - the increase in lease expense is a fixed cost.