Answer to Question #196730 in Microeconomics for haider

Question

The investors of Smith Autos have put up $500,000 to construct a building and purchase all equipment required to wash cars. The investors expect to earn a minimum return of 10% on their investment. If the money to set up the business had been borrowed from a bank instead, the car wash owners would have paid a 10% interest rate. The car wash is open 50 weeks per year and washes 800 cars per week. Whether operative or not, the company must pay $1,000 per week return to investors and $1,000 per week as insurance. The variable costs for the 800 weekly washes includes $1,000 labour cost and $600 materials cost. There are many car washes of equal quality and service in the area and they charge $5 per car wash.

a)     Based on your knowledge of the different forms of market structure, do you think Smith Autos should stay in business? Show calculations.                    (2 Marks)

Answer 1

Costs (per week)

- Return paid : $1000

- Insurance paid: $1000

- Variable costs incurred : $1600 (labor + materials)

TOTAL = $3600

Total Costs in a year = 3600 x 50 = $180,000

Earnings (per week)

No. of car washes per week = 800

Market price per wash = $5

TOTAL =(800×5)= $ 4000

Total Revenue per year = 4000 x 50 =$200,000

PROFIT = $20,000

The company is still earning profits of $20,000 each year after paying all costs incurred after paying interests and insurance. From the features mentioned, Smith Autos comes under market structure- Perfect Competition.

In perfectly competitive market, firms can only experience profits or losses in the short-run. In the long-run, profits and losses are eliminated because an infinite number of firms are producing infinitely-divisible, homogeneous products.

Smith Autos must keep running since they are earning profits.