7. The Maytag company produces output using labor (which it purchases on an as-n

Question

7. The Maytag company produces output using labor (which it purchases on an as-needed basis in the market for unskilled workers at a wage of S5 per hour) and one machine (which it is obligated to lease at a rental rate of S300 per hour). The planning horizon precludes Maytag from renting or purchasing any additional machines, as the current machine has a capacity of 80 units of output per hour, which exceeds the projected demand for the firm's product. The firm has no alternative use for the machine it leases, and the contract precludes it from subleasing it to another party. The company currently employs one worker who produces 10 units of output per hour. A recent report from the engineering department reveals that, given the plant's current capacity, two workers could produce 20 units of output per hour, three workers could produce 30 units of output per hour, and four workers could produce a total of 40 units of output per hour. a. Complete the following table: Hourly Cost Data, Maytag Company Output Variable Cost Marginal Cost Average Variable Cost 10 20 30 40 b. Suppose that Maytag can sell up to 40 units of output per hour at a price of S.60 per unit but cannot even get a penny for units produced in excess of 40 units per hour. How much output should Maytag produce each hour in order to maximize profits? c. At what price would Maytag find it profitable to shut down its operation?

Explanation / Answer

a) Here wage rate is $5 so wage bill is the only variable cost. Fixed cost is $300 so total cost is sum of variable cost and 300. Marginal cost = change in TC/ change in Q. AVC = VC/Q

b) If the price is $0.60, revenue column can be drawn as Price x Output. We see that losses are minimized when Q = 40.

c) At a price below 0.5, the firm should shut down because minimum of AVC is 0.5

Output Variable cost Fixed cost Total cost Marginal cost Average variable cost Revenue Profit 0 0 300 300 0 -300 10 5 300 305 0.5 0.5 6 -299 20 10 300 310 0.5 0.5 12 -298 30 15 300 315 0.5 0.5 18 -297 40 20 300 320 0.5 0.5 24 -296

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