As future employees, owners, and managers, you will not always receive informati
ID: 1118630 • Letter: A
Question
As future employees, owners, and managers, you will not always receive information in nice, neat packages. It will be up to you to determine what is important and what you can use to make decisions.
The South Dakota Student Supporters make two types of stuffed animals: stuffed coyotes and stuffed jackrabbits. (Assume that these have completely unrelated demand functions.) Both products are made in same factory and the fixed costs are shared, while the variable costs are attributable to each specific product. The company’s chief accountant reports that the corporation spent $20,000 in fixed costs and overhead to keep the factory operating last year. He notes that in the past year the total variable cost of making 1000 coyotes was $20,000, and that the total variable cost of producing 2000 jackrabbits was $30,000. Since jackrabbits represent 60% of the total variable costs of the firm ($30,000 of the $50,000 total variable cost for both products), the accountant allocates 60% of the company’s fixed costs to jackrabbits and the remaining 40% to coyotes. Thus he concludes that the fixed cost of producing the jackrabbits totals $12,000, and the total fixed cost attributable to coyotes is $8,000
The firm’s revenue records show that it sold the 1000 coyotes for $30 each, generating an income of $30,000, and that it sold the 2000 jackrabbits for $20 each, for revenues of $40,000. The company’s total combined revenues just equaled its costs at $70,000, so no profits were earned. The accountant says that his figures show that coyotes are profitable, that jackrabbits are not, and therefore the company should increase production of coyotes and decrease production and sales of jackrabbits. The firm’s marketing director has recently conducted some research on demand for the firm’s products, and has found that it could change the price of coyotes by 5% and sales would move in the opposite direction by 10%; however, if it changes the price of jackrabbits by 5%, sales move in the opposite direction by only 5%. The marketing director‘s advice is to raise the price of the good for which demand is less elastic and lower the price of the good for which demand is more elastic.
The production manager says that the cost of producing an additional jackrabbit is $12, while the marginal cost of coyotes is $25 and capacity is not constrained. His advice is, since the price of each good is greater than each product’s marginal cost, the firm should increase production and sales of both goods.
With whom do you agree, if anyone, based on the data the various people have provided? How would you advise the company? Should the prices of the products be increased or decreased and why?
Explanation / Answer
The above data clearly shows that the Coyotes are profitable and the firm is earning a revenue of $8000 right now and making a loss of $8000 on Jackrabbits. So it perfectly makes sense to reduce the production of Jack Rabbits and increase the production of Coyotes.
And the price elasticity of the Coyotes is more as compared to Jackrabitts so the price of the Coyotes can be reduced by 5% and this will boost the sales of the goods earning the profit by 10%.
I would advise the company to increase the production of the Coyotes as they are earning more profit and reduce its price by 5% and that production should be done by the resources freed from the production of JackRabbits. The price of the Coyotes can be reduced as it is more price elastic the reduction of price by 5% will increase the sales by 10%.
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