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Firm’s Output Price and the Calculated Average Variable Cost
Scenario A
Total Variable Cost = (Number of Workers * Worker’s Daily Wage)
TVC = 50,000 X 80
TVC = $4,000,000
Average Variable Cost = Total Variable Cost / Units of Output per Day
AVC = 4,000,000 / 200,000
AVC = $20
Average Total Cost = (Total Variable Cost + Total Fixed Cost) / Units of Output per Day
ATC = (4,000,000 + 1,000,000) / 200,000
ATC = $10
Worker Productivity = Units of Output per Day / Number of Workers
WP = 200,000 / 50,000
WP = $4
Scenario B
Assuming that the Total Fixed Costs= 3,000,000 then:
Total Variable Cost = (Number of Workers * Worker’s Daily Wage)
TVC = 50,000 X 80
TVC = $4,000,000
Average Variable Cost = Total Variable Cost / Units of Output per Day
AVC = 4,000,000 / 200,000
AVC = $20
Average Total Cost = (Total Variable Cost + Total Fixed Cost) / Units of Output per Day
ATC = (4,000,000 + 3,000,000) / 200,000
ATC = $35
Worker Productivity = Units of Output per Day / Number of Workers
WP = 200,000 / 50,000
WP = $4
Profits
Scenario A
Profit = Total Revenue (TR) – Total Cost (TC)
TR = Quantity (Q) * Price (P) TC = Fixed Cost (FC) + Variable Cost (VC)
Π= (200,000 X 25) – (1,000,000 + 4,000,000)
Π= 5,000,000 – 5,000,000
Π=$0
Profits made in this scenario equal $0
Scenario B
Profit = Total Revenue (TR) – Total Cost (TC)
TR = Quantity (Q) * Price (P) TC = Fixed Cost (FC) + Variable Cost (VC)
Π= (200,000 X 25) – (3,000,000 + 4,000,000)
Π= 5,000,000 – 7,000,000
Π=$ -2,000,000
Losses made in this scenario equal $200,000
Comparison of Firm A and Firm B
In both scenarios, the firm maintains its output price at $25 per item. The variable costs in each of the firm’s scenarios are maintained as $4,000,000 with the workers remaining as 50,000, therefore the average variable cost for both instances is $20. A change is however noted with regard to the average total cost factor due to the variations in the fixed costs. In Scenario A, the fixed cost is $1,000,000 therefore when combined with the variable costs of $4,000,000, the total cost amounts to $5,000,000. Averaging this across the 200,000 output level yields an average total cost of $10. On the other hand, Scenario B has a fixed cost of $3,000,000 therefore when combined with the variable cost of $4,000,000, the total cost amounts to $7,000,000 which when divided with the 200,000 output level amounts to an average total cost of $35.
In Scenario A, the firm should not shut down with its present $1,000,000 fixed costs since as noted within the preceding calculations the business yields $0 reflecting the break-even level. The break-even level is achieved when the total revenue and the total costs equal. Profitability is easily achieved from this point since the costs are covered by increasing the output element (Hoskins, McFadyen, & Finn, 2004). In Scenario B, the firm should be shut as the enhanced fixed costs of $3,000,000 when combined with the variable costs of $4,000,000 exceed the revenue leading to a loss of $2,000,000.
Dealing with the Loss in Scenario B
Number of Workers to be Laid Off = Loss / Daily Wage per Worker
W = 2,000,000 / 80
W = 25,000
A total of 25,000 workers should be laid off for a breakeven to be achieved
Worker Productivity = Units of Output per Day / Number of Workers
WP = 200,000 / 25,000
WP = $8
The change in worker productivity in Scenario B as compared to Scenario A is that it doubles; Scenario B has a worker productivity of $8 whereas Scenario A has a worker productivity of $4.
With the change in worker being lower than in Scenario A, the company should not be shut down since the given workforce actually constitutes to a breakeven point. This can be noted by the following computation:
Profit = Total Revenue (TR) – Total Cost (TC)
TR = Quantity (Q) * Price (P) TC = Fixed Cost (FC) + Variable Cost (VC)
VC = 25,000 X 80
VC = $2,000,000
Π= (200,000 X 25) – (3,000,000 + 2,000,000)
Π= 5,000,000 – 5,000,000
Π=$0
Assuming the given output is constantly held at 200,000 units, the workforce can achieve the break-even point by doubling their productivity levels as noted in the preceding worker output comparison. This means that for every single output that workers in Scenario A achieve, a double has to be achieved by every worker in Scenario B to attain the break-even point (Pirayoff, 2004).
Conclusion
In consideration to the management of the firm, an inference is obtained that indicates that with fixed costs being low, the company should stay afloat, if only by breaking even. When the company is breaking even, the management should enhance the organization’s output in order to enhance profitability (Baumol & Blinder, A. S. (2011). However, with an increase in the fixed costs, drastic measures should be taken to reduce elements that cause the output levels to be limited. In cases where the productivity levels provide a break-even point at constant output, layoffs may be avoided if the organization ensures that it does not fall behind its set targets both at individual and group levels.
References
Baumol, W. J., & Blinder, A. S. (2011). Economics: Principles and Policy. Upper Saddle River, NJ: Cengage Learning
Bernanke, B. (2003). Principles of microeconomics.Washington, DC: Sage Publishers
Hoskins, C., McFadyen, S., & Finn, A. (2004). Media economics: applying economics to new and traditional media. Lansing, MI: Sage Publications
Pirayoff, R. (2004). CliffsAP Economics Micro & Macro. New York, NY: John Wiley and Sons
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