Question

You are a newspaper publisher. You are in the middle of a one-year rental contract for your factory that requires you to pay $500,000 per month, and you have contractual labor obligations of $1 million per month that you can’t get out of. You also have a marginal printing cost of $.25 per paper as well as a marginal delivery cost of $.10 per paper. If sales fall by 20 per cent from 1 million papers per month to 800,000 papers per month,

A. what happens to the AFC per paper? How much is it?

B What happens to the MC per paper? How much is it?

C What happens to the minimum amount that you must charge to break even on these costs? How much is it?

Answer 1

We have

• Fixed cost = $500,000 per month + $1 million per month In total FC = 1,500,000 per month
• Marginal cost = $0.25 + $0.10 per paper = $0.35Q where Q is the number of papers.
• Total cost function is TC = 1,500,000 + 0.35Q

This implies that AFC = 1,500,000/Q and MC = $0.35 per paper.

Now sales are reduced by 20 per cent from 1 million papers per month to 800,000 papers per month. At Q = 1,000,000, AFC was 1,500,000/1,000,000 = 1.5 per paper. When Q falls to 800,000, AFC = 1,500,000/800,000 = 1.875. Hence AFC rises from 1.5 to 1.875 per paper

Marginal cost does not change because there is no change in printing cost and delivery cost.

Initially when sales were 1,000,000, Averate total cost was C/Q = (1,500,000 + 0.35*1,000,000)/1,000,000 = 1.85. This was the break even price before the sales drop. When sales are reduced, ATC becomes (1,500,000 + 0.35*800,000)/800,000 = 2.225

Hence the breake even price (where profit = 0) rises from 1.85 to 2.225.