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Analyzing cost elements of given firm

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A firm currently uses 50,000 workers to produce 200,000 units of output per day. The daily wage per worker is \$80, and the price of the firm's output is \$25. The cost of other variable inputs is \$400,000 per day. Although you do not know the firm's fixed cost, you know that it is high enough that the firm's total costs exceed its total revenue.

Assume that total fixed cost equals \$1,000,000. Calculate the values for the following four formulas:

Total Variable Cost = (Number of Workers * Worker's Daily Wage) + Other Variable Costs
Average Variable Cost = Total Variable Cost / Units of Output per Day
Average Total Cost = (Total Variable Cost +Total Fixed Cost) / Units of Output per Day
Worker Productivity = Units of Output per Day / Number of Workers

Then, assume that total fixed cost equals \$3,000,000, and recalculate the values of the four variables listed above. For both cases, calculate the firm's profit or loss.

For both sets of calculations, compare the firm's output price and the calculated average variable cost and average total cost. Should the firm shutdown immediately when the total fixed cost equals \$1,000,000? Should the firm shut down immediately when the total fixed cost equals \$3,000,000?

For one of the cases, if the firm can operate at a loss in the short-run, how many employees need to be laid off in order for the company to break even? To calculate the number of workers to be laid off, divide the loss for the two situations by the daily wage per worker. Given a lower number of employees now working at the company, what is the change in worker productivity? Is the change in worker too large, and the firm should shut down immediately? Or in your opinion, can the workers increase their productivity, assuming that the units of output per day remain fixed at 200,000 units, so that the firm operates at a break even state?

For both sets of calculations, compare the firm's output price and the calculated average variable cost and average total cost. Should the firm shutdown immediately when the total fixed cost equals \$1,000,000? Should the firm shut down immediately when the total fixed cost equals \$3,000,000?

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Solution Preview

Every firm selects the output level such that it makes maximum profit. It will try to minimize losses in case the firm is making losses.

In the given case, let us analyze firm's variable costs.
Number of workers employed=50000
Wage Rate=\$80 per day
Labor costs = Number of workers employed*wage rate= 50000*80=\$4,000,000
Other variable costs=\$400,000
Total Variable Costs=\$4000000+\$400000=\$4400000
Total output=200000 units
Average Variable Cost=AVC=Total Variable Costs/Total output
=4400000/200000
=\$22 per unit

Worker productivity= Units of Output per Day / Number of Workers=200000/50000=4
Price of firm's output=\$25 per unit
Contribution margin per unit=Price-AVC=\$25-\$22=\$3

It is know that a firm should continue to operate in the short run if average variable cost is lower than the average price level. At a point ...

Solution Summary

Solution calculates various costs and predicts the likely action that the given firm should undertake.

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