Problem

Ball Bearings Inc. faces costs of production as follows: a. Calculate the com...

Ball Bearings Inc. faces costs of production as follows:

a. Calculate the company’s average fixed costs, average variable costs, average total costs, and marginal costs.

b. The price of a case of ball bearings is $50. Seeing that she can’t make a profit, the Chief Executive Officer (CEO) decides to shut down operations. What are the firm’s profits/ losses? Was this a wise decision? Explain.

c. Vaguely remembering his introductory economics course, the Chief Financial Officer tells the CEO it is better to produce 1 case of ball bearings, because marginal revenue equals marginal cost at that quantity. What are the firm’s profits/losses at that level of production? Was this the best decision? Explain.

Step-by-Step Solution

Solution 1

771-14-5P SA: 3975

Q

TFC

TVC

AFC

AVC

TC

ATC

MC

TR

MR

Profit

0

$100

$0

  -

  -

$100

  -

  -

$0

  -

($100)

1

100

50

$100

50

150

150.00

50

50

50

($100)

2

100

70

50

35

170

85.00

20

100

50

($70)

3

100

90

33

30

190

63.33

20

150

50

($40)

4

100

140

25

35

240

60.00

50

200

50

($40)

5

100

200

20

40

300

60.00

60

250

50

($50)

6

100

360

17

60

460

76.67

160

300

50

($160)

Q= Quantity

TFC= total fixed cost

TVC= total variable cost

AFC= average fixed cost

AVC= average variable cost

TC= total cost

ATC= Average total cost

MC= marginal cost

TR= total revenue

MR= marginal revenue

Profit: at all the production levels from 0 to 6 units loss is incurred.

a)

AFC= average fixed cost

AFC= Total Fixed cost / output

AFC at unit 1= 100/1

= $100

AFC at unit 2= 100/2

= $50

AFC at unit 3= 100/3

= $ 33.33

AVC= average variable cost

AVC= Total Variable cost/ output

AVC at unit 1= 50/1

= $50

TC= total cost

Total cost is calculated by adding TFC and TVC

TC= TFC + TVC

TC for 2nd unit = 100 +70

ATC= Average total cost

It is the average of Total cost, calculated by dividing TC with output

ATC= TC/ Q

ATC of 4th unit= TC at 4th unit/ 4

= 240/4

= 60

MC= marginal cost

MC is the change in total cost for an additional unit of output.

MC= TCn – TCn-1

MC for 3rd unit= TC3rd – TC2nd

= 190 – 170

= 20

b)

At Price of $50 per case, to know the profit or loss we have to calculate total revenue.

Profit= TR – TC

If TC exceeds TR than we can infer that it’s a loss.

TR, is the total revenue earned by the firm, it is calculated by multiplying output with price.

TR= Quantity x Price.

Profit (or loss) = TR – TC

Profit (or loss) at 4th unit is = TR – TC

= 200 – 240

= - 240

Negative revenue means a loss to the firm, we can observe from the above table that at every level of output the firm incurred a loss.

At every level of output the firm is incurring losses.

Options available:

When shut down: The firm incurs a loss of $100, which is the fixed cost component.

By operating the firm when MR= MC at 4 units of output will cover all the operational expenses and also some part of the fixed cost component.

So, it is advisable to operate the firm and produce an output of 4 units, where the loss is minimized to $40, otherwise firm has to bear a loss of $100.

c)

Profit maximization output is produced when MR=MC, but at 1 unit output the firm incurs a loss of $100.

Instead it can go for 4 units of output, MR=MC= 50, and at this level of output all the variable expenses are covered and some part of fixed expenses are also covered by minimize the loss to $40.

Add your Solution
Textbook Solutions and Answers Search
Solutions For Problems in Chapter 14