Question

(b) Ahmad’s business is a profit-maximising, perfectly competitive firm. He mows lawns for $20 each. His total cost each day is $220, of which $40 is a fixed cost. He mows 10 lawns a day. (i) What is Ahmad’s profit/loss per day if he shuts down? (1.5 marks) (ii) What is Ahmad’s profit/loss per day if he does not shut down? (1.5 marks) (iii) What can you say about Ahmad’s short-run decision regarding shutdown? Explain your answer. (1.5 marks) (iv) What is his long-run decision regarding exit? (1.5 marks)

Answer 1

Answer : (i) Given, Total Cost (TC) = $220

Fixed Cost (FC) = $40.

Quantity = 10 lawns per day

Total Variable Cost (TVC) = TC - FC = 220 - 40 = $180

Average Total Cost (ATC) = TC / Quantity

=> ATC = 220 / 10 = $22.

Average Variable Cost (AVC) = TVC / Quantity
=> AVC = 180 / 10 = $18

Price of each lawn is $20.

Ahmed will shutdown his business when price = AVC. Now if Ahmed shutdown it's business then per lawn loss = ATC - AVC = 22 - 18 = $4. Per day loss = Per lawn loss * Quantity = 4 * 10 = $40.

So, if Ahmed shutdown his business then per day loss is $40.

(ii) If Ahmed not shutdown his business then per lawn loss = ATC - Price = 22 - 20 = $2.

Per day loss = Per lawn loss * Quantity = 2 * 10 = $20.

So, if Ahmed not shutdown it's business then per day loss is $20.

(iii) In short-run as the price is higher than AVC hence Ahmed should continue it's business. Because if Ahmed shutdown his business in short-run then the per day loss amount is $40 and if continue his business in short-run then the per day loss amount is $20. As in short-run the per day loss amount is less in continuous business in compared to shutdown hence Ahmed should continue his business in short-run although he faces loss.

(iv) If in long-run the price is less than AVC then the firm should exit from the market. So, in long-run if the price of each lawn fall below AVC then Ahmed should exit from the market. Because in this situation in long-run the total revenue is less than the total cost. As a result, Ahmed will face extreme loss in long-run. Hence if price is less than AVC in long-run then Ahmed should exit from the market.