Question

You are planning to start a new company. One set of decisions you are making has to do with the price you will charge and the way you will promote your product. Under the option we will call the high price option, you will charge $20.00 per unit. You will also have higher marketing expenses under this option. Therefore under the high price option you will have variable expenses of $17.00 per unit and monthly fixed expenses of $4,500. Under your second option, the low price option, you will charge $15.00 per unit and have variable expenses of $13.00 per unit and monthly fixed expenses of $2,000. Because of the higher marketing expenses under the high price option, the demand for your product is expected to be the same under both options.

(i) Show graphically the break-even point of the two options.
(ii) At what monthly unit sales will you achieve the same profit for both options?

Answer 1

To find the break-even and profit-maximizing points for Doggies Paradise Inc., you would calculate total revenue, total cost, marginal revenue, and marginal cost for different quantities of output. The break-even point is where total cost and total revenue intersect, whereas profit maximization occurs at a quantity where marginal revenue equals marginal cost, given that the price is above the average variable cost.

Step-by-step explanation:

When considering the break-even point and profit maximization for Doggies Paradise Inc., the key factors to consider include total revenue, total cost, and marginal revenues and costs. To determine the break-even point graphically, one would plot total costs (fixed plus variable) and total revenues on a graph and find the intersection point. For profit maximization, the firm should produce at a quantity where marginal revenue equals marginal cost (MR=MC), provided that price covers average variable costs.

CONCEPTUAL STEPS:

• Calculate total revenue (TR) by multiplying the quantity sold by the price for each level of output.
• Calculate total cost (TC) by adding fixed costs to the total variable costs for each output level.
• Find marginal revenue (MR) by noting the increase in total revenue for an additional unit of output.
• Calculate marginal cost (MC) by finding the increase in total costs when an additional unit is produced.
• Plot TR and TC on a graph to find the break-even point.
• Plot MR and MC on another graph to find the profit-maximizing quantity, where MR=MC.

If the price drops below average variable cost, the firm must decide whether to continue producing or shut down. In the scenario provided, if the farm can cover its variable costs but not all of its fixed costs, it continues to operate at a loss since this loss is smaller than the loss it would incur by shutting down and losing all fixed costs. If the price is so low that it does not cover variable costs, then the firm is better off shutting down to minimize losses.