Question

The owner of an Italian restaurant has just been notified by her landlord that the monthly lease on the building in which the restaurant operates will increase by 20 percent at the beginning of the year. Her current prices are competitive with nearby restaurants of similar quality. However, she is now considering raising her prices by 20 percent to offset the increase in her monthly rent. Would you recommend that she raise prices? Explain.

Short answer

So, it is not necessary to increase prices in the long run. The rent is a fixed cost, so for the long-run strategy, they would not recommend she raise prices.

Step-by-step solution

raisingthe price

A competitive industry permits enterprises to join and leave the market easily and has minimal barriers to entry. The term competitive refers to circumstances and operations in which individuals or businesses struggle with one another.

Explanation

In the longrun, they must consider total variable costs and revenue. If the total variable cost is lower than the total revenue, she can continue to charge the same price.So, it is not necessary to increase prices in the long run. The rent is a fixed cost, so for the long-run strategy, they would not recommend she raise prices.

In this situation, the rent is included in the fixed production cost. In a competitive industry, a profit-maximizing business is a price-taker; charging a price equals the marginal cost to maximize profit. Because a rise in fixed production costs does not affect marginal costs, the restaurant owner cannot raise prices.