ECO100 Chapter Notes - Chapter CH1: Sunk Costs, Price Elasticity Of Demand, Profit Maximization

On the first day of the New Year to get her business started, the owner/photographer of Exquisite Portraits Inc. paid $200 for business cards, $1000 for a listing in Yellow Pages, and $250 for an annual business license. She also leased a professional portrait camera and studio lighting equipment by signing an agreement to pay a monthly lease of $1000 each month for the next twelve months. This lease is ironclad: She must pay for all 12 months and she cannot sublease to anyone else. She rents her office and studio for $1,400 per month which must be paid at the beginning of each month. She does not have a lease on the office/studio, so she can vacate the office/studio at the end of any month should she decide to move to a new location or to go out of business. After she opens the office/studio on the first day of each month, her monthly cost of electricity for lighting the office and running her coffee machine is constant $45 per month, because she always keeps the lights on in the office and drinks the same amount of coffee no matter how many photos she shoots each month. Additional electricity is required for the portrait studio lights, which varies directly with the number of hours the lights are used each month for photo sessions. Last year, before starting this business, the owner of Exquisite Portraits Inc. earned a salary of $5000 per month working at a bank. Answer the following questions about the costs for Exquisite Portraits Inc.:

What are the monthly fixed costs, quasi-fixed costs, and variable costs for Exquisite Portraits Inc.?

If the owner of Exquisite Portraits Inc. wants to close her studio and go out of business at the end of August, identify her sunk costs and avoidable costs.

At the end of August, what role would the sunk cost play in the owner/photographer’s decision to go out of business?

In making her decision to start her own business, would her decision have been more or less difficult to make if sunk costs were zero at Exquisite Portraits? Explain.

1. Theoretically, in a long-run cost function:

a. all inputs are fixed

b. all inputs are considered variable

c. some inputs are always fixed

d. capital and labor are always combined in fixed proportions

2. The short-run cost function is:

a. where all inputs to the production process are variable

b. relevant to decisions in which one or more inputs to the production process are fixed

c. not relevant to optimal pricing and production output decisions

d. crucial in making optimal investment decisions in new production facilities

3. Break-even analysis usually assumes all of the following except:

a. in the short run, there is no distinction between variable and fixed costs.

b. revenue and cost curves are straight-lines throughout the analysis.

c. there appears to be perfect competition since the price is considered to remain the same regardless of quantity

d. the straight-line cost curve implies that marginal cost is constant.

Suppose you currently earn $19,000 a year. You are considering a job that will increase your lifetime earnings by $190,000 but that requires an MBA. The job will mean also attending business school for two years at an annual cost of $25,000. You already have a bachelor’s degree, for which you spent $80,000 in tuition and books.

Which of the above information is relevant to your decision on whether to take the job?