Question

An ice cream producer has fixed costs of $70,000 per month, and it can produce up to 15,000 ice cream tubs per month. Each tub costs $10 in the market while
the producer faces variable costs of $3 per tub.
a. What is the economic breakeven level of production?
b .Calculate the ice cream producer’s monthly profits at full capacity. What would happen to the monthly profits if another ice cream producer entered the
market, driving the price of ice cream tubs down to $7 per unit?

Answer 1

(a)

Let the breakeven level of production be x ice cream tubs per month

At break-even,

Total revenue = Total cost

(Price * break even level of production) = Fixed cost + Variable cost

$10x = $70,000 + $3x

10x - 3x = 70,000

7x = 70,000

x = 10,000

The economic breakeven level of production is 10,000 ice cream tubs.

(b)

Full capacity production = 15,000 ice-cream tubs

Calculate the profit -

Profit = Total revenue - Total cost

Profit = (Price * Full capacity production) - (Fixed cost + Variable cost)

Profit = ($10 * 15,000) - [$70,000 + ($3 * 15,000)]

Profit = $150,000 - [$70,000 + $45,000]

Profit = $150,000 - $115,000

Profit = $35,000

The ice-cream producer's monthly profit at full capacity is $35,000.

Now, price decreases to $7 per unit.

Calculate the profit -

Profit = Total revenue - Total cost

Profit = (Price * Full capacity production) - (Fixed cost + Variable cost)

Profit = ($7 * 15,000) - [$70,000 + ($3 * 15,000)]

Profit = $105,000 - [$70,000 + $45,000]

Profit = $105,000 - $115,000

Profit = -$10,000

The ice-cream producer incurs a monthly loss of $10,000 at full capacity when another ice cream producer enters the market and drive down the price to $7 per tub.