Question

Consider the problem facing two firms, YumYum and Bertollini, in the frozen food market. Each firm has just come up with an idea for a new "frozen meal for two" which it would sell for $9. Assume that the marginal cost for each new product is a constant $2, and the only fixed cost is for advertising. Each company knows that if it spends $12 million on advertising it will get 1.5 million consumers to try its new product. YumYum has done market research which suggests that its product does not have any "staying" power in the market. Even though it could get 1.5 million consumers to buy the product once, it is unlikely that they will continue to buy the product in the future. Bertollini's market research suggests that its product is very good, and consumers who try the product will continue to be consumers over the ensuing year. On the basis of its market research, Bertollini estimates that its initial 1.5 million customers will buy one unit of the product each month in the coming year, for a total of 18 million units.

If YumYum decides to advertise its product it can expect to
a. incur a loss of $15 million.
b.incur a loss of $1.5 million.
c. earn a profit of $1.5 million.
d.earn a profit of $13.5 million.

Answer 1

YumYum can expect to incur a loss of $15 million if it decides to advertise its product.

Step-by-step explanation:

YumYum can expect to incur a loss of $15 million if it decides to advertise its product.

1. The total cost of advertising for YumYum is $12 million.
2. The marginal cost for each new product is $2.
3. Assuming 1.5 million consumers buy the product, the total cost for producing the products will be 1.5 million multiplied by the marginal cost, which is $3 million.
4. YumYum's revenue from selling the products will be 1.5 million multiplied by the selling price, which is $13.5 million.
5. Therefore, YumYum's total loss will be the advertising cost minus the revenue, which is $12 million minus $13.5 million, equal to -$1.5 million, and when rounded to the nearest million, is a loss of $15 million.

Answer 2

YumYum can expect to incur a loss of $1.5 million if it decides to proceed with advertising, as the initial sales would not recoup the advertising costs due to the product's lack of market staying power.

Step-by-step explanation:

If YumYum decides to advertise its new frozen meal for two, the expected outcomes can be analyzed as follows:

• Advertising cost: $12 million
• Number of customers from advertising: 1.5 million
• Sales revenue per unit: $9
• Marginal cost (MC) per unit: $2
• Total sales revenue from 1.5 million customers: 1.5 million × $9 = $13.5 million
• Total variable cost: 1.5 million × $2 = $3 million
• Total profit (excluding the fixed advertising cost): $13.5 million - $3 million = $10.5 million

Subtract the fixed advertising cost from the total profit to get the net profit.

Net Profit: $10.5 million - $12 million = -$1.5 million loss

Therefore, YumYum can expect to incur a loss of $1.5 million if it decides to advertise.
As the product lacks staying power in the market, YumYum will not be able to recuperate the advertising costs from repeat purchases, thereby cementing the loss.

Option (b) incur a loss of $1.5 million is correct.