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You have opened your own word-processing service. You bought a personal computer, and paid \$5,000 for it. However, due to the cost changes in the computer industry, the current price of an equivalent machine is \$2,500. You could sell any used machine for \$1,000. If you were not word processing, you could earn \$20,000 per year at an alternative job. Assume that the interest rate is 10%. You can also hire an assistant who can do everything that you can do for \$20,000 per year (you would still continue to do word processing).
One person using one computer can produce 11,000 typed pages per year, and the price per page for your service is \$2.
You are considering three options: (1) expand your business by hiring an assistant. (2) leave your business the way it is (3) shut down. Based on the costs and revenues above, which should you do? Explain and show any relevant calculations.

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#### Solution Preview

You've been hired as a managing consultant by an unprofitable firm to determine whether it should shut down its operation. The firm currently uses 70 workers to produce 300 units of output per day. The daily wage (per worker) is \$100, and the price of the firm's output is \$30. The cost of other variable inputs is \$500 per day. Although you don't know the firm's fixed cost, you know that it is high enough that the firm's total costs exceed its total revenue. You know that the marginal cost of the last unit is \$30. Should the firm continue to operate at a loss?

The firm should operate as long as it can cover its variable expenses. These are 100x70 + 500 = 7500. The firm's revenue is 30 x 300 = 9000. The firm is covering its variable inputs and so it should remain open. In the long run, it may be able to reduce is fixed costs. If it cannot, it will then close.

You have been appointed "Global Manager" of a firm that has two plants, one in the United States and one in Mexico. Assume, you cannot change the size of the plants or the amount of capital equipment. The wage in Mexico is \$5. The wage in the U.S. is \$20. Given current employment, the marginal product of the last worker in Mexico is 100, and the marginal product of the last worker in the U.S. is 500.
a. Is the firm maximizing output relative to its labor cost? Show how you know.

Dividing the marginal product by the wage rate tells us how these plants compare ...

#### Solution Summary

Determining the best course of action in a word-processing business

\$2.19