Question

# Laura is a gourmet chef who runs a small catering business in a competitive industry. Laura...

Laura is a gourmet chef who runs a small catering business in a competitive industry. Laura specializes in making wedding cakes. Laura sells 20 wedding cakes per month. Her monthly total revenue is \$500. The marginal cost of making a wedding cake is \$20. She has fixed costs of \$200 and variable costs of \$400.

• Assuming their usual shapes, graph Laura’s average variable cost, marginal cost, average total cost. On your graph, clearly label the following: – The market price. – The quantity Laura is currently producing. – The value of average variable cost, average total cost, and marginal cost at the quantity being produced

. • If Laura is seeking to maximize short-run profit, should Laura shut down, produce more, produce less, or produce the same amount? Explain your logic and use your graph to help with your argument.

Laura sells 20 wedding cakes per month. Her monthly total revenue is \$500. Hence market price is TR/Q = 500/20 = \$25 per cake. The marginal cost of making a wedding cake is \$20.

She has fixed costs of \$200 and variable costs of \$400. This implies AVC = 400/20 = \$20 and TC = 400 + 200 = 600. Thus, ATC = 600/20 = \$30. Now see that MC = AVC = 20. Hence AVC is at its minimum.

Currently P > MC and P < ATC. But P > AVC, This shows that she should not shut down because she is covering her variable cost (which is \$400 while her revenue is \$500).

But she should produce more since P > MC and she can reduce her losses if she produces more. This will increase her MC upto the point where P = MC. She will still face a loss because price is fixed at \$25 but her losses can be reduced

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