Question

In: Economics

Smokey's Garage, Inc., provides routine auto diagnostics for customers in the Atlanta, Georgia, metropolitan area. Tests...

Smokey's Garage, Inc., provides routine auto diagnostics for customers in the Atlanta, Georgia, metropolitan area. Tests are supervised by skilled mechanics using equipment produced by two leading competitors in the auto test equipment industry. Staff at the company estimate that 4 tests per hour could be performed if they added another Sunny Tune System (STS) machine and 6 tests per hour could be performed on a new machine, the Car Care Tower (CCT). The STS can be leased at a cost of $5,000 per month, and the CCT can be leased at a rate of $9,000 per month. Labor to operate either of the machines would cost $3,000 per month. All other costs are fixed. On average, each machine is operated 25 eight-hour days per month. Smokey’s receives $15 for each test performed.

A. Compute and interpret the net marginal revenue products for the two types of equipment?

B. Should the company lease more STS machines? What about more CCT machines? Explain your answer.

Solutions

Expert Solution

a)

First we estimate the marginal cost and marginal revenue for STS machine.

Marginal Cost=Lease amount+labor Cost=5000+3000=$8000 per month

Number of tests that can be conducted=25*8*4=800 per month

Marginal Revenue=15*800=$12000 per month

Marginal Net Revenue=MR-MC=12000-8000=$4000

A STS machine will give a marginal net revenue of $4000 per month i.e. it will add $4000 per month to profit.

Now we estimate the marginal cost and marginal revenue for CCT machine.

Marginal Cost=Lease amount+labor Cost=9000+3000=$12000

Number of tests that can be conducted=25*8*6=1200 per moonth

Marginal Revenue=15*1200=$18000 per month

Marginal Net Revenue=MR-MC=18000-12000=$6000

A CCT machine will give a marginal net revenue of $4000 per month i.e. it will add $4000 per month to profit.

b)

Marginal net revenue is positive for STS machine. there is no harm in employing additional STS machines.

Marginal net revenue is positive for CCT machine. there is also no harm in employing additional CCT machines.

We know that there are always some constraints on space, labor or number of tests to be carried out. These factors can influence the decision.

We find that marginal net revenue is higher in case of CCT. So, in absence of any other information, it is advisable to employ more of CCT machines.

Rahul Sunny answered 9 hours ago
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