In: Economics
Lisa is a Vice-President at the Head Office of a national insurance company and Fred is State Manager for Queensland Branch. They are discussing the Queensland Branch’s budget for next year. They both expect that the branch’s client base will expand by about 10%. Fred is asking for a 10% increase in the budget (after adjustment for inflation). Lisa is offering only a 5% increase. Fred worries that this will mean a fall in the quality of services for Queensland clients. Lisa is confident that the new budget will allow Fred to maintain, or even improve, service quality. From your knowledge of economic theory, what factors would you see as relevant in assessing whether Lisa's offer is a reasonable one?
Note: Please explain with the help of economic theories and relevant factors. A detailed answer would be highly appreciated. Thank you!
Rise in client base demands increase in budget to maintain services to clients. Both quality and quantity of services are inevitable to keep and sustain client base.
Fred wants to increase budget by same proportion as the client base so that quality could be maintained. On other hand, Lisa supports only 5 % rise in budget. Simply speaking, 10 % rise in client base can be maintained with 10% rise in budget.
But Lisa offer to increase 5 % is also relevant. This can be understood and explained with help of economic theory. It is associated with Economies of Scale. Rise in budget by 5 % would be able to cater to demand of extra 10% clients. Due to economies of scale, rise in 10 % of client can easily be catered through the 5 % rise in budget.