Answer to Question #196733 in Microeconomics for shabbir

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.

b)     Graphically represent the company's performance, showing profit or loss. (1 Mark)

Answer 1

This company is operating in a perfectly competitive market and is a price taker. It can continue to operate so long as it recovers its variable cost, i.e., revenue per unit is higher than variable cost per unit. The variable costsof this company is labor and material cost, which add up to:

$1000 + $600 = $1600

(the insurance cost and return to investors are not included since these are fixed costs that need to be incurred irrespective of number of cars washed)

Per unit variable cost is $1600/800 = $2 per wash

per unit revenue is $5 (given)

Since revenue per unit is higher than variable cost per unit, it should stay in business

b)