Econ Question (Qbank 40213)

John Klement is a soybean farmer who harvests 125,000 bushels of soybeans annually. Klement’s fixed costs are \$200,000 and his variable costs are \$5 per bushel. Soybeans are currently priced at \$5.35 per bushel. Based on his estimates, Klement sees soybean prices being relatively stable for the next two years, then increasing to \$7.00 per bushel due to increased demand from Japan. What action should Klement take? Klement should: A) shut down for two years and then restart his business. B) cut his production by 50% for the next two years and then resume full production. C) shut down his business permanently. D) continue operating his business as usual.

I thought it was (A) as it costs him \$6.60 vs the \$5.35 he’ll get to sell them. The actual answer is: Your answer: A was incorrect. The correct answer was D) continue operating his business as usual. Since Klement is selling soybeans, a common commodity, he is a price taker and therefore can not adjust the price. He should continue operating his business as normal as he is currently covering variable costs and part of fixed costs. In two years from now, he will be able to cover both fixed and variable costs and be able to make a substantial profit. I"m a bit confused as to which point it’d be uneconomical for him to continue trading? thanks

I got D, too P > VC ===== keep the plant up. My trick here was to read the answers before the question, then you know what to LOOK for.

It would be uneconomical when he cant cover his FCs…

yeah but you stay in production if you can cover your avc i think

ln1234 Wrote: ------------------------------------------------------- > I thought it was (A) as it costs him \$6.60 vs the > \$5.35 he’ll get to sell them. The actual answer > is: > > Your answer: A was incorrect. The correct answer > was D) continue operating his business as usual. > > Since Klement is selling soybeans, a common > commodity, he is a price taker and therefore can > not adjust the price. He should continue operating > his business as normal as he is currently covering > variable costs and part of fixed costs. In two > years from now, he will be able to cover both > fixed and variable costs and be able to make a > substantial profit. > > I"m a bit confused as to which point it’d be > uneconomical for him to continue trading? thanks Ok this makes sense. He is taking in a profit, but curbing the loss until he can actually make a profit in 2 yrs. grrrr.

Short run decisions don’t encompass entry/exit into an industry. Your short run decision is to keep producing or shut down. Long run decisions involve entry/exit. Variable cost per unit is your shutdown point. If you’re above AVC, you keep producing to mitigate some of your fixed costs. If below, then just by continuing operations you are further putting yourself in the hole. That’s not a sound economic choice. In the long run, if price which equals marginal revenue goes up by enough to cover both AVC and AFC (which equal ATC), then at a minimum you will earn a normal profit and will be indifferent to staying/exiting the industry. At an economic profit, you will stay.

> > In the long run, if price which equals marginal > revenue goes up by enough to cover both AVC and > AFC (which equal ATC), then at a minimum you will > earn a normal profit and will be indifferent to > staying/exiting the industry. At an economic > profit, you will stay. good good point = normal profit is = to ZERO econ profit. normal profit includes opportunity costs and op costs = implicit and explicit

Shit!! I missed this question today… Good question and Good explanations above ! Thanks

if he shuts down his business or reduces his production temporarily, he will loose his current turnover without any extra advantage after 2 yrs when prices go up A and B are thus incorrect, C is obviously not correct, so answer is D this could be interesting if Klement could stock up some inventory