Question

a) A firm has three different production facilities, all of which produce the same product. While reviewing the firm’s cost data, Jasmin, a manager, discovers that one of the plants has a higher average cost than the other plants and suggests closing that plant. Another manager, Joshua, notes that the high-cost plant has high fixed costs but that the marginal cost in that plant is lower than in the other plants. He says that the high-cost plant should not be shut down but should expand its operations. Who is right?

b) Katie’s Quilts is a small retailer of quilts and other bed linen products. Katie currently purchases quilts from a large producer for $100 each and sells them in her store at a price that does not change with the number of quilts that she sells. Katie is considering vertically integrating by making her own quilts. If the fixed cost of vertically integrating is $10,000 and she can produce quilts at $50 per quilt, her total cost of producing quilts, q, herself is C=10,000+50q. How many quilts does Katie need to sell for vertical integration to be a profitable decision?

Answer 1

a) Marginal cost is the cost added when an additional product is produced.Since the high-cost plant has low marginal cost ,when the production is increased, the increase in revenue will be higher when compared to increase in costs i.e the profits will increase(since the selling price of product is same but the cost price has decreased).Also as the production will increase,the fixed cost per product will decrease(TC/q =(FC/q)+(VC)).Therefore, Joshua is right.

b)