Question

Consider a firm that sells its product in both the U.S. and the U.K. U.S. demand is for​ 10,000 units, and the U.S. production capacity is​ 8,000 units. Demand in the U.K. is for​ 6,000 units, and the U.K. production capacity is​ 12,000 units. Production cost in the U.S. is​ $10, and production cost in the U.K. is​ ₤4. The current exchange rate is​ $2.8 =​ ₤1. The shipping cost is​ $1 per unit for any units shipped between the two countries. Sales prices equate to​ $100 in each country. How many units should be made in each​ country?

A.

U.S.​ = 16,000; U.K.​ = 0

B.

U.S.​ = 8,000; U.K.​ = 8000

C.

U.S.​ = 8,000; U.K.​ = 0

D.

U.S.​ = 8,000; U.K.​ = 6,000

E.

U.S.​ = 0; U.K.​ = 16,000

F.

U.S.​ = 10,000; U.K.​ = 6,000

G.

U.S.​ = 4,000; U.K.​ = 12,000

Answer 1

Let's first calculate the cost of production in each country in terms of dollars.

So the production in US costs $10.

And the production costs 4 poundsim UK and the exchange rate is equal to,

$2.8 = 1 pound

So 4 pounds will be equal to,

= 4 × 2.8

= $11.2

So the production in UK in terms of $ costs $11.2.

So the cost of production is lower in US, so the full capacity needs to be utilised in the US.

So 8,000 units will be produced in US and rest will be produced in UK.

The demand in US is equal to 10,000 units and the production capacity is 8,000 so there is a shortage of

= 10,000 - 8,000

= 2,000 units.

And the demand is UK is equal to 6,000 units and the production capacity is equal to 12,000 units. Since the total production capacity has been exhausted in US so UK must produce what it demands plus the shortage in US. So the total production that needs to take place at UK is equal to,

= demand in UK + shortage in US

= 6,000 + 2,000

= 8,000 units

So the production in UK must be equal to 8,000 units.

So the correct option must be option b, that is US should produce 8,000 units and UK should produce 8,000 units.