Question

A manufacturer of electronics products is considering entering the telephone equipment business. It estimates that if it were to begin making wireless telephones, its short run cost function would be as follows:

Q (thousands)         AVC                AC                  MC

9                                  41.10              52.21              30.70

10                                40.0                50.0                30.10

11                                39.1                48.19              30.10

12                                38.40              46.73              30.70

13                                37.90              45.59              31.90

14                                37.60              44.74              33.70

15                                37.50              44.17              36.10

16                                37.60              43.85              39.10

17                                37.90              43.85              39.10

18                                38.40              43.96              46.90

19                                39.10              44.36              51.70

20                                40.0                45.0                57.10

1. Suppose the average wholesale price of a wireless phone is $50. Do you think this company should enter the market? Explain.
2. How much is the profit (loss) earned by this firm at the optimal level of production.
3. Suppose the firm does enter the market and that over time increasing competition causes the prices of phones to fall to $35. How would that affect the firm’s production levels and profit? Explain.

Answer 1

A) At any point of production, cost of production (AC) is appearing to be less than the selling price of $ 50 per unit. Hence, company shall enter market to earn profits.

B) Optimal level of production is 20,000 units where the average cost is $ 45 per unit. Hence profit per unit = $ 5 per unit (50-45). Total profit at this optimal level = 5*20000= $ 1,00,000

C) In case the increasing competition causes the price to fall to $ 35 per unit, the firms production level shall be 15,000 units where average cost per unit is $ 37.5, which is minimum in all the levels of production, leading to minimum loss to the company. Here, company will incur loss of $ 2.5 per unit (37.5-35).