Question

Barbour Electric is considering the introduction of a new product. This product can be produced in one of several ways:

(a) using the present assembly line at a cost of $20 per unit,
(b) using the current assembly line after it has been overhauled (at a cost of $5,000 ) with a cost of $18 per unit; and
(c) on an entirely new assembly line (costing $30,000 ) designed especially for the new product with a per unit cost of $15.
Barbour is worried, however, about the impact of competition. If no competition occurs, they expect to sell 10,000 units the first year. With competition, the number of units sold is expected to drop to 6,000 . At the moment, their best estimate is that there is a 40% chance of competition. They have decided to make their decision based on the first-year sales.
(a) Develop a decision table showing the payoffs.
(b) What decision should they make? Hint: develop an EOL table and make a decision based on this table.

Answer 1

To determine the profit maximizing quantity, we need to calculate total revenue, marginal revenue, total cost, and marginal cost for each output level. The profit maximizing quantity occurs when marginal revenue equals marginal cost. In this case, the profit maximizing quantity is three units.

Step-by-step explanation:

To calculate total revenue, we multiply the selling price by the quantity of output. For example, when producing one unit, the total revenue is $72. The marginal revenue is the change in total revenue when one additional unit is sold. For example, the marginal revenue from selling the second unit is $72.

To calculate total cost, we add the fixed cost to the variable cost. For example, when producing one unit, the total cost is $164. The marginal cost is the change in total cost when one additional unit is produced. For example, the marginal cost of producing the second unit is $84.

The profit maximizing quantity occurs when marginal revenue equals marginal cost. From the table, we can see that when producing three units, the marginal revenue is $72 and the marginal cost is $114. Therefore, the profit maximizing quantity is three units.