You are in the middle of a one year rental contract for your factory that requer

Question

You are in the middle of a one year rental contract for your factory that requeres you to pay 500,000 per month, and you have contractural labor obligations of $1 millon per month that you can't get out of. You also have a marginal printing cost of .25 per paper as well as a marginal delivery cost of .10 per paper. If sales fall by 20% from 1 million papers per month to 800,000 papers per month, what happens to the average fixed cost per paper, the MC paper, and the minimum amount that you must charge to break even on these costs?

Explanation / Answer

The following are fixed costs: Rent 500000/mo Labor 1000000/mo The following are variable costs: Printing $0.25/paper Delivery $0.10/paper So, the fixed costs are 1500000/mo and the marginal cost is 0.35/paper. AFC = FC/Q At 1000000 papers, AFC = 1500000/1000000 AFC = $1.50/mo At 800000 AFC = 1500000/800000 AFC = $1.875/mo MC = $0.35 per paper and does not change with the number of papers. The minimum amount that we must charge to break even is average total cost. ATC = AFC + AVC ATC = FC/Q + VC/Q VC = MC*Q ATC = FC/Q + MC ATC = FC/Q + 0.35 At Q = 1000000, ATC = 1.50 + 0.35 ATC = $1.85 At Q = 800000 ATC = 1.875 + 0.35 ATC = $2.225 The AFC changes from 1.50 to 1.875. That's an increase of 0.375. The MC remains constant at 0.35 because the printing and delivery costs per paper are unchanged. The minimum amount that we must charge to break even increases from 1.85 to 2.225. That is an increase of 0.375.

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