Question

4. Two firms in the same industry sell their product at $12 per unit, but one firm has TFC = $160 and AVC = $4 while the other has TFC’ = $285 and AVC’ = $2.50.

a. Determine the breakeven quantity of each firm.

b. Find the degree of operating leverage for each firm at Q = 35 and Q =40.

Answer 1

a) Breakeven quantity of firm 1 = TFC / (Selling price - AVC)

                                    =160 / (12 - 4) = 20

Breakeven quantity of firm 2 = TFC' / (Selling price - AVC')

                                    = 285 / (12 - 2.50) = 30

b)

Firm 1:

At Q = 35

TFC = 160

TVC = AVC * Q = $4 * 35 = $140

Total sales = P * Q = $12 * 35 = $420

Contribution = Total Sales - Variable cost = 420 - 140 = $280

Operating leverage = Contribution / (Contribution - Fixed cost)

                               = 280 / (280 - 160) = 2.33

At Q = 40

TFC = 160

TVC = AVC * Q = $4 * 40 = $160

Total sales = P * Q = $12 * 40 = $480

Contribution = Total Sales - Variable cost = 480 - 160 = $320

Operating leverage = Contribution / (Contribution - Fixed cost)

                               = 320 / (320 - 160) = 2

Firm 2:

At Q = 35

TFC = 285

TVC = AVC * Q = $2.50 * 35 = $87.5

Total sales = P * Q = $12 * 35 = $420

Contribution = Total Sales - Variable cost = 420 - 87.5 = $332.5

Operating leverage = Contribution / (Contribution - Fixed cost)

                               = 332.5 / (332.5 - 285) = 7

At Q = 40

TFC = 285

TVC = AVC * Q = $2.50 * 40 = $100

Total sales = P * Q = $12 * 40 = $480

Contribution = Total Sales - Variable cost = 480 - 100 = $380

Operating leverage = Contribution / (Contribution - Fixed cost)

                               = 380 / (380 - 285) = 4