Final answer:
Using plantwide overhead costs that do not correlate with labor or machine hours can lead to distorted product costs, affecting pricing and profitability. As labor costs rise due to union negotiations, firms may adjust by investing in machinery, enhancing labor productivity but potentially reducing employment. Other variables, such as fixed costs and diseconomies of scale, also influence firm decisions and costs.
Step-by-step explanation:
The risk of using plantwide overhead costs that do not move in tandem with plantwide direct labor hours or machine hours is that it may result in inaccurate costing and pricing decisions. When overhead costs such as maintenance or utilities don't correlate well with the chosen allocation base (labor or machine hours), applying a single overhead rate can distort product costs. This is particularly true for firms that have a diverse range of products requiring different amounts of labor and machine time.
When unions negotiate higher wages, firms might respond by adjusting their production methods. For instance, if union workers secure a wage increase from $16 to $24, a firm may shift to using more machinery (physical capital) and less labor to maintain cost efficiency. However, this labor productivity improvement comes at the cost of hiring fewer workers.
Moreover, other cost elements could be more significant than labor or capital costs. For example, firms with low fixed costs, like leaf raking services, face different financial pressures compared to manufacturing plants. Plants running continuously may experience diseconomies of scale with increasing marginal and average costs due to factors like the need for frequent equipment maintenance and management complexities.