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Firm's - Essay Example

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From this result, we add Other Variable Costs to find the Total Variable Cost. The number of workers and their wages are classed as variables because can fluctuate. Other Variable…
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For the Total Variable Cost, we multiply the number of workers by the average wage per worker. From this result, we add Other Variable Costs to find the Total Variable Cost. The number of workers and their wages are classed as variables because can fluctuate. Other Variable Costs typically remain the same. The formula is shown below:
Total Variable Cost = (Number of Workers*Worker’s Daily Wage) + Other Variable Costs
Total Variable Cost = (50,000*80) + 400,000 = $4,400,000
For the Average Variable Cost, we take the above sum (Total Variable Cost) and divide it by the units of output per day. This is an extension of the first equation because it takes the Total Variable Cost and breaks it down into Variable Cost per unit of output. This is an important figure to know because from this, the revenue price for each product can be calculated. The formula is shown below:
Average Variable Cost = Total Variable Cost / Units of Output per Day
Average Variable Cost = 4,400,000/200,000 = $22
To determine Average Total Cost, we need to add the Total Fixed Cost to the above equation. The Total Variable Cost and Total Fixed Cost are summed together and divided by the units of output per day. This figure is another important number to know because it can be added together with the Average Variable Cost to determine the cost per unit. In this case, it would be $49 ($22+$27). The formula for Average Total Cost is displayed below:
Average Total Cost = (Total Variable Cost + Total Fixed Cost) / Units of Output per Day
Average Total Cost = (4,400,000+1,000,000)/200,000 = 27
To find out Worker Productivity, we simply take the units of output per day and divide it by the number of workers. This will give us the number of units that each worker produces each day. This formula is shown below:
Worker Productivity = Units of Output per Day / Number of Workers
Worker Productivity = 200,000/50,000 = 4
For the above scenario, we can calculate the firm’s profit or loss as follows:
Profit/Loss = (Units of output per day*Revenue per unit) – (Total Variable Cost + Total Fixed Cost)
Profit/Loss = (200,000*25) – (4,400,000 + 1,000,000) = 5,000,000 – 5,400,000 = –400,000
If we assume that the Total Fixed Cost is now 3,000,000, we can recalculate the above equations as follows:
TVC = No change = 4,400,000
AVC = No change = 22
ATC = (4,400,000+3,000,000)/200,000 = 37
WP = No change = 4
If we recalculate the firm’s profit or loss, we get the following outcome:
Profit/Loss = (200,000*25) – (4,400,000 + 3,000,000) = 5,000,000 – 7,400,000 = –2,400,000
Both sets of calculations have the firm’s output price at $25 and the Average Variable Cost at $22. The difference is in the Average Total Cost. The first scenario has ATC at $27, while the second scenario has an ATC of $37. However, in both of these cases, the AVC is lower that the output price. Because of this, the firm should not be shut down immediately in either case.
In terms of break-even numbers, we need to divide the total loss by the daily wage of each worker. For the first example, the $400,000 loss would be divided by $80 per worker (400,000/80), which equals 5,000 workers. If 5,000 workers were laid off, it would leave a workforce of 45,000. If we assume that production remains steady at 200,000 units per day, this means that Worker Productivity would have to increase from 4 units per day to 4.4 units per day (200,000/45,000).
The second case would have a loss of $2,400,000 divided by $80 per worker (2,400,000/80), which would result in a loss of 30,000 workers, leaving the workforce at 20,000 workers. If we assume that production output (200,000 units) remains the same, then each worker would have to produce 10 units per day (200,000/20,000).
For the first case, the firm should not shut down because the remaining workers can increase their output by 11% (4.4/4) to allow the firm to breakeven. On the other hand, in the second scenario, the firm should not be shut down immediately because AVC is under price output ($22 versus $25) However, in the long-term, the firm should consider shutting down because the workers would have to significantly increase their output from 4 units to 10 units (a 250% increase). This is simply not attainable, so the firm has no other option but to close down. Read More
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