Resources, Read/review the following resources for this activity:
Initial Post Instructions
For the initial post, address the following:
Suppose you decide to open a small pizzeria in your neighborhood. You rent a space (signing a 1-year lease to do so), you employ two workers, and you take out a loan at a local bank and use the money to purchase 2 ovens. Six months later, a large pizza chain (like Domino) opens a pizza place two blocks away from yours. As a result, the revenue you receive from your pizzeria, while sufficient to cover the wages of your employees and the costs of ingredients and utilities, doesn’t cover all your rent and the interest and repayment costs on the loan you took out to purchase the ovens. Briefly explain the steps you will take to successfully stay in business.
Week 3 Discussion: Opening of the Small Pizzeria in the Neighborhood
The opening of the small pizzeria in the neighborhood has been done by renting space by signing a one-year lease, employing two workers, and also taking a loan from a local bank to purchase two ovens. Now according to the concept of production and cost, the cost which has to be paid by the firm regardless of its level of output produced is regarded as the fixed cost. Some examples of fixed costs are loan payments, lease and renting costs, bills of utility, business licenses that are valid for a particular time, etc. (Greenlaw & Shapiro, 2017). The cost which changes with the change in the output produced by a firm is regarded as the variable cost. Some examples of the variable cost are the cost of the raw materials to be used, supplies of production, transportation cost, cost of packaging outputs, cost of labor, etc. If the production is zero the variable cost is also zero and hence it changes with the proportion or amount of the output (Greenlaw & Shapiro, 2017). Hence, using the concept of production and cost, it can be said that the cost required to employ two workers in the pizzeria is the variable cost. On the other hand, the cost required for signing the one-year lease for renting the space for the pizzeria and the loan taken from the bank to purchase the two ovens fall under the fixed cost that is to be borne.
Now, after six months of being in the business in the neighborhood, an outlet of a large pizza chain (like Domino) opens a pizza place two blocks away from my pizzeria. Since this new pizzeria is a large pizza chain, hence the overall output of the pizza company is much higher than the output of my pizzeria, and hence the average cost of producing a pizza by the new pizza place is much less in comparison to my average cost of producing a pizza in the pizzeria. Hence, competition in the market is created and it is required to take steps to successfully stay in the business. According to the concept of production and cost, the magnitude of profit of a company and hence the chance of staying in the business can be depicted by comparing the price of the output with the average variable cost of producing the output. If the price is greater than the average variable cost then the company can stay in business, if the price is equal to the average variable cost, then the business has reached its shutdown point but can still operate in the business, lastly, if the price is less than the average cost then the business cannot operate anymore in the business and hence has to shut down (Greenlaw & Shapiro, 2017). The revenue received from the pizzeria is sufficient to cover the wages of the employees and the costs of the ingredients and utilities but does not cover all your rent and the interest and repayment costs on the loan that was taken out to purchase the ovens. Hence, the business can cover the variable costs, but not being able to cover the fixed costs, implies that the business has reached its shutdown point.
The pizzeria, to successfully stay in business, has to cover all the variable costs incurred during the process of production. It can stay in the business as long as it can cover its variable costs that is till it is at the shutdown point. This is true in the short run. The business can again restart the business, in the long run, when it has recovered from all the variable and fixed costs and when the price is greater than the variable cost and there are no fixed costs, all costs are variable.
A Greenlaw, S., & Shapiro, D. (2017). [eTextbook] Principles of Microeconomics 2e.