Question

Suppose at some point after you graduate you decide to open a bakery that sells cupcakes. You estimate that the startup costs are equal to $100,000. You can either borrow this $100,000 from a bank, and pay $1,000/month to the lender, or withdraw this amount from your savings account.

a) Should the decision of whether you borrowed the $100,000 or withdrew it from your savings account matter in terms of how many workers to hire, what price to charge for baked goods, or how much to spend on advertising? Why or why not?

b) In addition to the startup costs described above, suppose the marginal costs of making cupcakes are constant at $1/cupcake. What are your average total costs/cupcake at Q=1,000 and Q=50,000? What economic concept applies to this situation?

Answer 1

Answer-

a) Here the cost of the firm increase by $100 each month, If we withdraw the money the firm doesnt need to pay the interest.These affects the decision making fo the .firm what price to charge and how much to produce.

b) With MC =$1, FC= 100,000
The TC ( Q= 1000) = 100,000 + 1x1000
=101000

Hence ATC = 101

TC ( Q= 50000) = 100000 + 1x 50000
= 150000

hence ATC = 15

So for the firm as Q rises, ATC falls. The firm has economies of scale of falling ATC for large units of out put .



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