Q = 20,000 pairs a year, P = $10, FC = $60,000, VC = $120,000. 10 percent increase in output would not affect fixed costs but would reduce average variable cost by 40 cents.
Price reduction of 5 percent to increase sales, total revenues, and profits. Ed = −2.
a. Evaluate the impact of the proposal to cut prices on
(i) total revenue will increase, because demand is elastic and sales will increase by 2*5 = 10 percent. So, TR1 = 10*20,000 = 200,000, TR2 = P*Q = 9.5*22,000 = $209,000
(ii) total cost will change too: TC1 = $180,000, TC2 = 60,000 + ((120,000/20,000) - 0.6)*22,000 = $178,800, so total costs will decrease.
(iii) total profits will increase TP1 = TR - TC = 20,000, TP2 = 209,000 - 178,800 = $30,200.
b. If average variable costs are assumed to remain constant over a 10 percent increase in output, TC2 = 60,000 + 6*22,000 = 192,000, the effects of the proposed price cut on total profits will be TP2 = 209,000 - 192,000 = 17,000, so total profits will decrease.
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