Question

You work for an insurance company that processes claims through both a newer, larger high-tech facility and an older, smaller low-tech facility. Each month, the high-tech facility is working at capacity handling 10,000 claims. It incurs $100,000 in fixed costs and $100,000 in variable costs (which is almost entirely labor costs). Each month, the low-tech facility handles 2,000 claims, incurs $16,000 in fixed costs and $24,000 in variable costs (which is almost entirely labor costs). If you anticipate that in the short-run the number of claims will decrease by 1,000 per month, where does it most make sense (from a cost point of view) to reduce claims processing and lay-off workers first?

Answer 1

Solution:

Facility	No.of claims	FC	VC	TC	VC per claim	TC per claim
High-tech	10,000	100,000	100,000	200,000	$100,000/10,000 = 10	$200,000/10,000 = $20
Low-Tech	2,000	16,000	24,000	40,000	$24,000 /2,000 = 12	$24,000 / 2,000 = $20

　

As fixed costs are fixed thus need to be ignored for this problem, and thus consider only the average variable cost for processing the claim at each location. The above calculations reflects that Low-Tech facilty has higher average variable cost, thus from the low tech facilty lay off the workers.