Production and Perfect Competition pt 2 microeconomics

Sir Shannon Scott Williams


Unit 3: Individual Project
Production and Perfect Competition

American InterContential University, Online

Professor Ramin Maysami, Ph.D., CFP.

January 21th, 2011

When it comes to production, units produced per day consist of many factors in order to create a good.  Labor, electricity, training, repair, and other necessary cost are examples to these factors.  In order for a facility to remain in production, revenue must be greater than the cost per day or else the business is at a loss, most likely end in shut down.  In this paper, there is a given scenario where a plant is facing a loss in daily revenue due to exceeding cost.  To determine whether or not the plant should shut down or continue production, readers will be able to understand the calculations to make these decisions.

            In the given scenario there is a plant that employer’s 50,000 workers who produce 200,000 units per day.  The cost of each daily wage per worker is $80.  Units produced generates the plant $25 per unit.  To operate under these conditions, there are other variable inputs totaling $400,000 per day.  Another cost, fixed cost, which is unknown, it causing the plants total cost to exceed total revenue per day.  To determine whether or not the plant should shut down, or continue to operate, you are to assume a fixed cost of $1 million and $3 million.  The calculations provided will determine shut down or continuing production.
To begin with, you need to understand that if Total Revenue (TR) is greater than Total Costs (TC) then the plant can continue production.  However, if TR is less than TC, then shut down production.
The first calculation is to discover the Total Revenue being generated per day.  You know that the employees produce 200,000 units where each unit sells for $25.  So multiply total units by sale price.
Total Revenue (TR) = 200,000 x $25 = $5,000,000 per day.
Next, determine the Total Cost; however you do not know what the total fixed cost, so base the determination on Total Variable Costs.
Total Variable Cost (TVC) is equal to the total number of workers (50,000) multiply by the daily wage of each worker ($80) plus other variable costs ($400,000).
Total Variable Cost (TVC) = (50,000 x $80) + $400,000 = $4,400,000
Based on these calculations for Total Revenue and Total Variable Costs, it is clear that the plant generates enough revenue to cover the various costs.  Since the plant is able to cover its cost and continue production.
TR $5 million/per day > TVC $4,400,000/per day = Continue production

However the Fixed Costs are not implemented into this determination, so you need to assume on two different occasions that the fixed costs are $1 million per day and $3 million per day.  This input will ultimately decide whether or not to shut down or continue production.

Let us assume first that the Fixed Cost is $1 million per day.  The Total Variable Cost (TVC) will remain unchanged for this calculation, number of employees (50,000) multiply by daily wage ($80) then add various input costs ($400,000).

Total Variable Cost (TVC) = (50,000 x $80) + $400,000 = $4,400,000
Next the Average Variable Cost (AVC) which is equal to the Total Variable Cost ($4.4 million) divided by the total units of output per day (200,000).
Average Variable Cost (AVC) = $4,400,000 / 200,000 = 22
Next, the Average Total Cost (ATC) which are equal to the Total Variable Costs ($4.4 million) plus the Total Fixed Cost ($1 million), then divided by the units of output per day (200,000).
Average Total Cost (ATC) = ($4,400,000 + $1,000,000) / 200,000 = 27
Finally there is Worker Productivity (WP) which is equal to the total units of output per day (200,000) divided by the total number of employees (50,000).
Worker Productivity (WP) = 200,000 / 50,000 = 4

                   Assuming that the Total Fixed Cost is $3 million per day, you will use the same calculations as before to determine plant shutdown or continuing production.
Total Variable Cost (TVC) = (50,000 x $80) + $400,000 = $4,400,000
Average Variable Cost (AVC) = $4,400,000 / 200,000 = 22
Average Total Cost (ATC) = ($4,400,000 + $3,000,000) / 200,000 = 37
Worker Productivity (WP) = 200,000 / 50,000 = 4

                   Since you have assumed the Fixed Cost, you can now calculate Total Cost in which you take the TVC and add the Fixed Cost.
Assuming the Fixed Cost for $1 million:
Total Cost = TVC + Fixed Cost = $4,400,000 + $1,000,000 = $5,400,000
Assuming the Fixed Cost for $3 million:
Total Cost = TVC + Fixed Cost = $4,400,000 + $3,000,000 = $7,400,000
The result is a higher cost than revenue being generated; Profit or Loss details the result by taking the TR minus the TC.
Profit or Loss ($1million) = $5,000,000 - $5,400,000 = -$400,000 loss each day.
Profit or Loss ($3million) = $5,000,000 - $7,400,000 = -$2,400,000 loss each day.
The loss is due to the ATC being higher than the AVC.  The plants units sell for $25 each.  If the plant operates on TVC, it can generate profit based on the AVC ($22/unit), a $3 gain.  However, if the Fixed Cost is added, this results an ATC increasing the price cost.  At $1million Fixed Cost, the ATC per unit is $27, a $2 loss.  At $3 million Fixed Cost, the ATC per unit is $37, a $10 loss.

                   Based on the assumption for a Fixed Cost of $1 million, these costs are exceeding daily revenue.  The plant could shut down temporary or lay-off some of its employees to reach a break-even-price, whenever price equals minimum average, (Krugan, Wells, 2009, p. 340).  Issuing a lay-off, you first need to calculate Profit or Loss then divide by daily wage to determine how many employees need to be laid off.
Lay-off = ($5,000,000 - $5,400,000) / $80 = -5000 employees
Since 5,000 employees are to be laid-off, this will change the daily production.  Going back to the Worker Productivity formula, you calculate the change.
Worker Productivity = 200,000 / 45,000 = 4.44

                   As you can see the change in units produced is increased because the new work force has to make-up for laid-off employees.  This isn’t much work to be made up, so this would be the best option for the plant under the conditions of a Fixed Cost for $1million.
Assuming the Fixed Cost for $3 million:
Total Cost = $4,400,000 + $3,000,000 = $7,400,000
In this assumption, the Total Cost highly exceeds Total Revenue and must face an immediate shut down.
TR < TC = $5,000,000 < $7,400,000 = Immediate shut down
A lay-off would not be an option due to the amount make-up work needed from employees.  The new productivity is more than double the amount.
Lay-off = ($5,000,000 - $7,400,000) / $80 = -30,000 employees
Worker Productivity = 200,000 / 20,000 = 10

                   In conclusion, the scenario is an example of what many plants face whenever costs exceed revenue.  As for this situation, the plant can operate for a short time with minor lay-offs only with a Fixed Cost of $1 million.  It is unfortunate how the fate of the plant must cease production with the Fixed Cost for $3 million.  From calculation to calculation, you should now be able to determine a similar situation if ever encountered.

Armstrong, Kotler. (2009). Introduction to Marketing (9th Ed.).
Pearson Education, Inc, Upper Saddle River, New Jersey.

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