Question

Modifying a product to increase its “value added” benefits customers and can also enhance supplier profits. For example, suppose an improved version of a product increases customer value added by $25 per unit. (In effect, the demand curve undergoes a parallel upward shift of $25.)a. If the redesign is expected to increase the item’s marginal cost by $30, should the company undertake it? b. Suppose instead that the redesign increases marginal cost by $15. Should the firm undertake it, and (if so) how should it vary its original output and price?

Answer 1

a. The improved version of the product is appreciated by the consumers and their willingness to pay increases by $25. the reveune thus increase by $25 * Q

While the Marginal cost of improving the product is $30. The increase in total cost would be $30 *Q

Change in Profits = New revenue - New Costs

Change in Profits = 25*Q - 30*Q

Change in Profits = -5Q

the company thus should not iundertake this redesigning.

b.

The improved version of the product is appreciated by the consumers and their willingness to pay increases by $25. the reveune thus increase by $25 * Q

While the Marginal cost of improving the product is $15. The increase in total cost would be $15 *Q

Change in Profits = New increased revenue - New increased Costs

Change in Profits = 25*Q - 15*Q

Change in Profits = 10Q

the company thus should undertake this redesigning.

The company, since consumers willingness to pay is higher than the cost, should apply value based pricing using its brand value. It may increase the price by $25 or reduce the quantity so that the new increased revenue of 25*Q should equal the 25*Q1 where Q1 < Q.