Final answer:
The decision to establish a new plant to meet increased demand should be based on analyzing economies of scale, production costs, and demand. Fixed costs of the new plant need to be weighed against potential production cost savings and market prices to determine if the operation will be profitable. A careful balance between fixed costs, variable costs, and production output is essential for a profit-maximizing strategy.
Step-by-step explanation:
When considering the expansion of production facilities, it is crucial to evaluate the setup based on the concept of economies of scale. In the context provided, figures such as 33.5 or 19.5 show that as production plants grow from S to L, the average cost of production decreases significantly. For instance, Plant S's average cost of production is $30 per toaster oven, while Plant L's cost is only $10 per toaster oven due to the advantage of economies of scale. However, it's important to note that these economies of scale do not improve beyond a certain level of output (150 units in this case), as seen with Plant V, which has the same average production cost as Plant L despite being larger.
Considering the fixed costs of $15,162 per month for the new plant, the analysis would involve calculating the potential average cost of production at different output levels, understanding the market demand, and then comparing these costs to the current and projected selling prices. One key aspect is whether the new plant would produce at a level that reaches the minimum efficient scale where the per-unit production costs are minimized, which in the provided examples occurs at an output level of 150 units.
Furthermore, all the variable costs that fluctuate with production levels must be added to the fixed costs to determine the total cost of producing each unit. This cost analysis will assist in understanding whether the new plant's operation at a certain level of output can cover its fixed and variable costs and generate a profit. It's also crucial to consider the profit maximizing or loss minimizing strategy by comparing if operating at a loss is better than bearing just the fixed costs without any production, as seen in Figure 8.6.