With current technology, suppose a firm is producing 400 loaves of banana bread daily. Also assume that the least-cost combination of resources in producing those loaves is 5 units of labor, 7 units of land, 2 units of capital, and 1 unit of entrepreneurial ability, selling at prices of $40, $60, $60, and $20, respectively.
If the firm can sell these 400 loaves at $2 per unit, will it continue to produce banana bread? If this firm’s situation is typical for the other makers of banana bread, will resources flow to or away from this bakery good?
The Correct Answer and Explanation is :
Correct Answer:
The firm will not continue to produce banana bread at this point, and resources will flow away from the banana bread industry.
Explanation:
The firm is producing 400 loaves of banana bread daily, and each loaf is sold for $2. To determine whether the firm will continue producing, we need to calculate the firm’s total revenue and total cost, and then assess whether the firm is earning a profit or incurring a loss.
Total Revenue:
Total revenue (TR) is calculated as the price per unit times the quantity sold.
- Price per loaf = $2
- Quantity sold = 400 loaves
So, the total revenue is:
[
TR = 2 \times 400 = 800 \, \text{dollars}
]
Total Cost:
Next, we calculate the total cost (TC), which is the sum of the costs of labor, land, capital, and entrepreneurial ability. We are provided with the prices of these resources and the quantities used in production.
- Labor: 5 units at $40 each → $5 \times 40 = $200
- Land: 7 units at $60 each → $7 \times 60 = $420
- Capital: 2 units at $60 each → $2 \times 60 = $120
- Entrepreneurial ability: 1 unit at $20 → $1 \times 20 = $20
The total cost (TC) is:
[
TC = 200 + 420 + 120 + 20 = 760 \, \text{dollars}
]
Profit or Loss:
Now, to determine whether the firm is making a profit or incurring a loss, we subtract total cost from total revenue:
[
\text{Profit (or Loss)} = TR – TC = 800 – 760 = 40 \, \text{dollars}
]
The firm is making a profit of $40. However, the economic profit is not the sole factor determining whether the firm will continue producing in the long run.
If this firm’s situation is typical for other makers of banana bread, resources will flow away from the industry because the firm is only earning a modest profit of $40, which may not be sufficient to attract more resources to the industry. Moreover, if other firms are also experiencing similar profits or even losses, there might be a tendency for resources to shift to other industries offering higher returns, such as those that provide higher or more stable profits. As a result, the supply of banana bread may decrease or stabilize, which could influence the market in the future.
Therefore, the firm will likely continue to produce, but if profits don’t improve or if losses begin to accumulate, the long-term sustainability of banana bread production might be at risk.