Managing in the Information Economy - Assignment Example

I. Rich Manufacturing Why do many firms use cost-plus pricing for supply contracts? In the actual practice, with cost-plus pricing strategy, the firm designates a percent mark-up over costs. In theory, cost-plus pricing carries advantages which include the following: easy to calculate, simple to administer, requires minimal information, tends to stabilize market, protects supplier from unexpected cost increases, and it is believable to salespeople and customers (Brickley, Smith & Zimmerman, 2009; Apte & Karmarkar, 2007, p.108; Holden & Burton, 2010). However, the most advantageous part of this pricing strategy on the part of the firm is for it to cover its operating costs. With cost-plus pricing, the firm can just increase the price. Price increase is possible due to the fact that at some point, the production costs of a product may not be clear in advance. This literally may have significant advantage in cases of supply contracts. 2. What potential problems do you envision with cost-plus pricing? Although cost-plus pricing strategy may have advantages, it also has remarkable drawbacks which include the following: ignoring the demand, image, and market positioning; favouring historical accounting costs rather than replacement value; applying standard output level to allocate fixed costs; offering few incentives for efficiency, as costs are passed off to customers; ignoring the role of customers and the value they drive; and creating a competitive disadvantage using average costs (Brickley, Smith & Zimmerman, 2009; BPP Learning Media, 2009, p.302; Holden & Burton, 2010). Perhaps, the most striking of all of these is on how the costs are clearly passed off to customers. Cost-plus pricing may therefore not that competitive in a marketplace where there are new entrants, especially those willing to compete with price by and lowering down their price offerings to generate a market share or acceptance. At some point, cost-plus pricing may trigger a less affinity (less demand) for a certain service or product offering in the long run as competition arises. 3. Should Gina contest the price increase? Explain. Cost-plus pricing is a safer pricing strategy on the part of Bhagat Incorporated due to production costs that may not be clear beforehand. It is a natural practice that when a manufacturing company set the price of a good, the cost of labour is always taken into account (Brickley, Smith & Zimmerman, 2009; Krauss & Johnson, 2006, p.211; Campbell, 2003, p.167). Labour costs are categorised either direct or indirect (Sears, Sears & Clough, 2010, p.46). The indirect labour costs can be reduced (Appelbaum, 200, p151; Roderhorst, 2009, p.80). If Bhagat has so much increase in its indirect labour costs, then this could be taken advantage of in order to reduce the final price of its product offering. In addition, at some point, labour costs can be considered fixed, due to the point that Bhagat can just increase its capacity for production in order to cope with its actual production cost. These are some important information that Gina needs to find out prior to purchasing the maximum 100,000 machine parts. On the other hand, she might only consider 50,000 parts and look for an alternative option. II. Personal Video Recorders (PVRs) 1. PVRs will greatly decrease the demand from advertisers because it definitely allows users to snip commercials. PVRs encourage users to skip commercials and so advertisers may no longer have an optimum chance for them to expose the users to their product and service offering promotions. 2a. Considering that all costs are fixed, there is no other way in order to cover the costs, but ensure that the revenue is maximised. The price and the number of minutes to be offered for advertisement are important factors for considerations in finding for the revenue. To find for the price that should be charged, the minutes of advertising to sell, and the total revenue, the given equation of the quantity demanded for advertising on the show which is Qd = 30 – 0.0002P + 26V should be used for the computation. Based on the given assumption, let V = 1, then the equation becomes Qd = 56 – 0.0002P. This means that the price (P) to be charged should be dependent on how many minutes of advertising to sell as quantity demanded (Qd). This also means that when P = 0, Qd = 56. Thus, the remaining 4 minutes should be donated for public service announcements, which means that only 26 minutes will be available for companies to advertise their products considering that the running time for the show itself is only 30 minutes. Thus, based on the equation (Qd = 56 – 0.0002P, if V = 1), when Qd = 26, then P = 150,000. This means that if the offered time for advertising is 26 minutes, then the probable price (P) for one-minute advertising is (150,000/26), which is equivalent to 5,769.2 per minute. By using the given equation, the relationship between the variables follows the theory of the law of demand, which states that when the price is higher, the demand will substantially decrease and vice versa (Brickley, Smith & Zimmerman, 2009; Arnold, 2013, p.58). However, the law of supply states that the supplier would be willing to produce more offering if the price is high and vice versa (Brickley, Smith & Zimmerman, 2009; Mankiw, 2008, p.73). Considering that to cover the fixed cost the company should listen to the demand, then it is implied that it makes sense to have 5,769.2 as price per minute advertisement, leading to150, 000 as revenue for a 26-minute advertisement (5,769.20 x 26), based on the given demand equation model. Figure 1. Demand 2b. Let us take the case of price P = 150,000, the equilibrium price as constant. Thus, Qd = 26V. Suppose V = 1, then Qd = 26. Then let V = 0.5, then Qd = 13. The equation Qd = 26V is a line shown in Figure 2, having a slope equivalent to 26 or as computed, m = 26. The “viewer elasticity” is therefore elastic. This means that a 1 unit increase in the number of expected viewers will lead to at least 26 unit of increase in the quantity demanded. This only means that the quantity demanded for commercial time slot is sensitive to the number of viewers. In other words, advertisers are willing to advertise their product or service offerings if there is substantial number of viewers. Computation: Viewer elasticity = [(26 - 13)/(1- 0.5)] = 26 Figure 2. Viewer elasticity 3. Networks such as CBS, NBC, ABC, and FOX rely on the number of clients who are willing to avail time slots from their programs for advertisements. This is one way these networks will generate income for their programs. They rely on their sponsors. However, if more viewers begin using PVRs, allowing them to skip advertisements, the networks can no longer rely on the revenue linked to advertisements. As a result, their revenue will substantially decrease, knowing that the “viewer elasticity”, as calculated, is elastic. Meaning, the sponsors are much willing to advertise if there are many viewers who could view their advertisements and vice versa. 4. The long-run effect if a significant proportion of the viewers begin adopting “advertising snipping” systems is the shutting down of the major networks. This is due to the fact that they can no longer address their production cost if their revenue cannot substantially address both their fixed and variable costs. In theory, the total cost, which is composed of the fixed cost and the variable cost, should be lower than the revenue (Brickley, Smith & Zimmerman, 2009). For instance, if there are still fixed costs for instance to address and the networks do not have capacity to produce higher revenue due to lack of sponsors, they will shut down in the short run and then can hardly recover in the long-run, leading them to shutdown forever. 5. Major commercial networks and producers of programming for these networks co-exist in the business arena. One can hardly survive without the other. As more consumers adopt PVRs, programming should be regulated. Producers of programming should limit the programs shown to those viewers employing PVRs. This is a way for major commercial networks and producers of TV programming to create a demand for commercial advertisements. Furthermore, it is important to tie up with the manufacturers of PVRs and provide them with incentives for showing commercial from major networks. This will enhance further the opportunity for the visibility of advertisements to the target audience. III. PowerGuns Co. a. The production function is Q = 25LK. Since L = 25, and K = 40, then Q = 25,000. The current average product of labour for PowerGuns Co is therefore (25,000/25) which is equivalent to 1,000. The current marginal product of machines provided there is 1 unit increase in machines is [(25,625 – 25,000)/(40-41)], which is equivalent to 625. b. Consider our production function Q = 25LK. We need to place multipliers m and create a new production function. Thus, Q = 25(L*m)(K*m) = 25KLm2 = Qm2. Considering that m > 1, then m2 > 1. The new production function has increased by more than m, which means there is an increasing returns to scale. A production function is said to display increasing returns to scale if the output increases by more than m if the inputs are increased by m (Van den Berg & Lewer, 2007, p.106). c. The total cost of the current production of PowerGuns in a month is [($3,000 x 25) + ($6,000 x 40)] which is equivalent to $315,000. To find for the average cost to produce a shooting gun, the total cost is divided by the total quantity Q. That is $315,000 divided by 25,000, which is equal to $12.6. Change in total cost divided by the change in quantity output is the marginal cost formula (Brickley, Smith & Zimmerman, 2009). Therefore, the marginal cost of producing one additional gun is 12.6 divided by 1, which is equivalent to 12.6. d. The law of diminishing returns is a concept in economics stating a specific point at which the level of profits or benefits incurred is less than the amount of money, energy or something invested (Hirschey, 2008, p.251). Other definitions state that a diminishing return occurs when there is an input variable that once increased will lead to the decrease of marginal per unit output (Brickley, Smith & Zimmerman, 2009). In the given production function, when either of the labour or machine is increased in input, the quantity output will have to increase, at some point. Thus, the given production function does not display the characteristic of law of diminishing returns. IV. Should a company ever produce an output if the managers know it will lose money over the period? Explain. Losing money over the period is common particularly in start-up business. If the company is determined to stay up in business in the long-run, producing an output even if such would mean lose of money over the period at some point in the process is quite necessary. There are certain fixed costs that need to be optimised in the long run, and therefore, the basis of evaluation should not be in the short run. Business and its capacity and productivity should be considered in the long run. After all, business with fixed costs cannot go in the short run (Gwartney et al., 2014, p.446; Welch & Welch, 2009, p.342). This means that in order to generate profit, some business will have to stay long in the business and cover their costs. For example, a firm that is putting up and establishment has remarkably incurred a huge amount of start up cost. This huge amount of start up cost cannot be literally gained back in a short period of time. The business will have to stay long and continue to produce an output, as a way of reaching the intended economic gain in the future. Thus, on a case-to-case basis, the company should produce an output even if it will lose money over the period. Losing money is the associated cost of production, but the produced products or services will lead to incurring of return of investment. V. The Johnson Oil Company has just hired the best manager in the industry. Should the owners of the company anticipate economic profits? Explain. In economics, it is assumed that rational people take an action when the marginal benefits of that action are higher than the marginal costs (Brickley, Smith & Zimmerman, 2009). In other words, one important reason as to why the “The Johnson Oil Company” has just hired the best manager in the industry is due to target goals, and one of them for sure is profit. Hiring the best manager in the industry has the associated cost, and Johnson should be able to cover this cost, by equating the manager’s performance to his/her intended salary. Not only that, in order to cover this cost, the company looks forward to seeing economic profits sooner or later. This behaviour is observed in the concept of integrating the ideas of marginal benefits and the marginal costs. Therefore, based on this economic concept, it is clear that the owners of the company should anticipate economic profits, as a way of covering the marginal costs of hiring the best manager in the industry. After all, the manger’s actual performance may be equated to how much the company is making economic profits. References Appelbaum, E. (2000). 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