Question

Lorie teaches singing. Her fixed costs are \(\$ 1,000\) a month, and it costs her \(\$ 50\) of labor to give one class. 'I'he table shows the demand schedule for Lorie's singing lessons. $$\begin{array}{cc} \begin{array}{c} \text { Price } \\ \text { (dollars per lesson) } \end{array} & \begin{array}{c} \text { Quantity demanded } \\ \text { (lessons per month) } \end{array} \\ \hline 0 & 250 \\ 50 & 200 \\ 100 & 150 \\ 150 & 100 \\ 200 & 50 \\ 250 & 0 \end{array}$$ a. Do you expect other firms to enter the singing lesson business and compete with Lorie? b. What happens to the demand for Lorie's lessons in the long run? What happens to Lorie's economic profit in the long run?

Short answer

Other firms might enter due to initial profits, increasing competition. This will decrease Lorie's demand and reduce her economic profit to zero in the long run.

Step-by-step solution

Understanding Fixed and Variable Costs

Lorie's fixed costs are \(1,000 per month, which do not change regardless of the number of lessons given. Each lesson costs \)50 in labor, which is a variable cost that depends on the number of lessons given.

Determining Total Cost

Total cost is the sum of fixed costs and variable costs. For a given number of lessons, the total variable cost is the price per lesson multiplied by the number of lessons. The total cost formula is:\[ \text{Total Cost} = \text{Fixed Cost} + \text{Variable Cost} = 1000 + 50Q \]where \( Q \) is the number of lessons.

Calculating Revenue and Profit

Revenue for a given price and quantity of lessons is calculated as \( \text{Revenue} = P \times Q \). Profit is the difference between revenue and total cost:\[ \text{Profit} = \text{Revenue} - \text{Total Cost} \]For each price point, calculate the revenue, total cost, and profit.

Analyze Market Entry

Analyze the profitability at each price level. If there are economic profits (where \( \text{Profit} \gt 0 \)), other firms may be incentivized to enter the market due to the attractiveness of profitable opportunities.

Expectations in the Long Run

In the long run, if new firms enter the market, the increased competition will decrease the demand for Lorie's singing lessons. This will lower the price she can charge and reduce her economic profit.

Economic Profit in the Long Run

In a competitive market, economic profit tends to zero in the long run because new entrants drive prices down to the point where firms just cover their costs. Lorie's economic profit will also decrease and may potentially become zero in the long run.

Key concepts

fixed costs

Fixed costs are the expenses that do not change regardless of the level of production or services offered. In Lorie's case, her fixed costs are \(\$ 1,000\) per month. This means she will incur this charge every month irrespective of how many singing lessons she gives. Fixed costs often include items like rent, insurance, and salaries of permanent staff. For any business, understanding fixed costs is crucial for setting the base level of revenue needed to cover these expenses before making a profit. Keep fixed costs in mind as they remain constant and must be paid regardless of activity levels.

variable costs

Variable costs change directly with the level of production or services provided. For Lorie, each singing lesson costs \(\$ 50\) in labor, which is a variable cost. So, the more lessons she gives, the higher her total variable costs will be. Variable costs include expenses like raw materials, hourly wages, and utilities tied directly to production. Calculating these is important to understand the operational dynamics as they influence the total cost based on the output level. Always account for variable costs when planning how to price services or products to ensure profitability.

total cost

Total cost is the sum of fixed and variable costs. Lorie's total cost for giving \( Q \) lessons can be calculated using the formula: \[ \text{Total Cost} = \text{Fixed Cost} + \text{Variable Cost} = 1000 + 50Q \] This formula helps to determine the overall expenses for running a business at any production level. It's crucial to differentiate total costs because they directly impact how you set prices and manage profitability. Paying attention to both fixed and variable elements is essential for accurate financial planning and analysis.

revenue calculation

Revenue is calculated by multiplying the price per lesson by the number of lessons given. For Lorie, if she charges \( P \) dollars per lesson and gives \( Q \) lessons, the revenue formula is: \[ \text{Revenue} = P \times Q \] For instance, if she charges \( \$100 \) per lesson and gives 150 lessons, her revenue would be \( \$15,000 \). This straightforward calculation resides at the heart of any financial analysis as it helps determine how much money is coming in from the business operations. Monitoring revenue is important for assessing the performance and making informed decisions.

economic profit

Economic profit is the difference between total revenue and total costs (both fixed and variable). Lorie’s profit is determined using the formula: \[ \text{Profit} = \text{Revenue} - \text{Total Cost} \] Positive economic profit indicates that the business is making more than enough to cover all its costs, while a negative profit suggests a loss. In highly competitive markets, new entrants can drive down prices and profits. Economic profit is vital as it measures the real profitability after all costs, including opportunity costs, are accounted for. It’s a comprehensive way to assess if staying in business or shifting strategies makes financial sense.

market competition

In any business, market competition refers to the presence of other firms providing similar products or services. For Lorie, if her singing lessons are profitable, other firms might enter the market, attracted by the potential gains. Increased competition generally leads to a reduction in prices and profit margins as firms strive to attract customers. Understanding the market dynamics is crucial as it influences pricing, marketing strategies, and operational adjustments. In competitive markets, keeping abreast of competitors’ actions and industry trends is essential for long-term success.

long-run equilibrium

Long-run equilibrium in a perfectly competitive market occurs when firms make zero economic profit, meaning total revenue equals total costs. For Lorie, new firms entering the market will eventually lower the demand for her lessons, decreasing the price she can charge. In the long run, this leads to a situation where she only makes just enough to cover her costs, with no excess profit. Understanding this concept helps businesses anticipate market adjustments and informs strategic decisions whether to innovate, cut costs, or explore new markets. It is a vital principle in predicting long-term sustainability and stability in a competitive environment.