Problem 1: At a recent meeting, the president and the CEO of Production, Inc. go
ID: 1178010 • Letter: P
Question
Problem 1: At a recent meeting, the president and the CEO of Production, Inc. got into a heated argument about whether or not to shut down the company's plant in Flint, Michigan. The plant currently loses $50,000/month. The president of Production, Inc. argued that the plant should continue to operate until a buyer is found for the facility. This argument was based on the fact that the plant's fixed costs are $61,000/month. The CEO disagreed over this point, arguing that fixed costs do not matter in making the shutdown decision.
Problem 2: A monopolist has determined that marginal revenue is $2.00 and average cost is $1.75. It has also determined that the lowest sustainable average cost is $1.75. To maximize profit, should the firm lower its price, increase its price, or leave the price unchanged? How would you change your response if marginal revenue is $1.50? Explain your responses.
Explanation / Answer
Problem 1:
The Plant must continue to operate because fixed cost must be paid regardless of whether a firm operates or not. In this Scenario, the company os recovering at least 11,000$ (and the variable costs) because the loss is only $50k while the fixed costs are $61k. Shutdown is the case when the loss exceeds the fixed costs.
Answeringthe CEO: The CEO's point ( fixed costs do not matter in making the shutdown decision) is valid only in the case when you take variable costs as shutting down eliminates all the variable costs. Here the variable costs are not taken into consideration hence his argument is invalid.
Problem 2:
Follow this rule:
when a monopoly increases amount sold, it has 2 effects on total revenue:
*More output is sold
*To sell more price must decrease
Like a competitive firm, the monopolist produces the quantity at which
marginal revenue equals marginal cost. The difference is that for the monopo-
list, marginal revenue no longer equals price.
The price that the monopolist charges is the price at which buyers are willing
to buy the profit-maximizing quantity.
In the first case, he will try to bring down the marginal revenue equating it with average cost i.e. $1.75 (Decreasing it)
In the second case, he will try to increase the marginal revenue to equate the average cost.(Increase it)