Question

Redstone Clayworks, Inc. is located in Sedona, Arizona and manufactures clay fire pits for patios. They are one of about two dozen firms around the world that manufacture and sell clay fire pits for retailers such as Home Depot, Lowe’s, Front Gate, and other upscale home product chains. There is virtually no product differentiation. A clay fire pit is a clay fire pit.

Assume that the world market demand and supply curves for clay fire pots intersects at $300 per unit.

The spreadsheet below gives some of Redstone’s production cost data. A template for the spreadsheet is provided in the Course Materials.

Q	TC	TFC	TVC
0	6,000	6,000	-
100	12,000	6,000	6,000
200	15,000	6,000	9,000
300	21,000	6,000	15,000
400	33,000	6,000	27,000
500	48,000	6,000	42,000
600	65,000	6,000	59,000
700	83,000	6,000	77,000
800	102,000	6,000	96,000
900	123,000	6,000	117,000
1000	158,000	6,000	152,000

Add columns to show, respectively, average fixed cost (AFC), average variable cost (AVC), average total cost (ATC), and short-run marginal cost (SMC). Then, add columns to show, respectively, total revenue (TR), marginal revenue (MR), total profit, average profit, and profit margin.

Place your completed spreadsheet in the Drop Box,and use it to answer questions 1-7. Your spreadsheet and calculations are worth 15 points and count as 500 words toward your word count requirement.

Your spreadsheet must include formulas showing how you arrived at the calculations. As an alternative, you may also submit a document showing your step-by-step calculations for each of the cells. You will not receive credit if you do not show your work using one of these two methods.

For Questions 2, 4, and 5, be sure to employ both of the General Rules for Implementing the Output Decision in your explanations.

A detailed explanation should be given for each question.

1. If Redstone wishes to maximize profit margin, how many units should it produce?   

2. What level of output should the manager of Redstone choose to produce? Explain your choice in at least 100 words.

3. Are your output choices the same in questions 1 and 2? Why or why not? Explain using at least 100 words.

4. Make a copy of your spreadsheet and double the fixed costs. How does this change your answer to question 2? Explain in detail.

5. Make another copy of your spreadsheet and suppose that fire pits fall out of fashion causing prices fall worldwide to $85. How many units should the manager choose to produce? Explain.

6. Should the firm shut down in the short-run? Explain in detail why or why not.

7. Should the firm shut down in the long run? Explain in detail why or why not.

8. Airline industry experts generally believe that because of the "highly competitive" nature of U.S. airline markets, it is usually impossible to pass on higher jet fuel prices to passengers by raising ticket prices.

What factors do you suppose contribute to making U.S. airline markets "highly competitive"?

Accepting the premise that U.S. airline markets are indeed highly competitive, analyze in both the short run and long run the difficulty of raising ticket prices when jet fuel prices rise.

Answer 1

1.

2.

3. For maximizing profit margin (76.66%) , firm should produce 300 units.

4. In a short run, the firm would maximise its profits producing on the positively sloped portion of SMC curve and above the minimum of AVC. As we can clearly see, SMC starts to rise after 200 units, so firm should produce more than 200 units. The producer will not produce below AVC because if he does there is not going to be only a fixed cost but also a loss on each unit that he produces, so he will shut down below AVC. Therefore, going by these two conditions, firm would produce 300 units. This can be clearly seen when we plot the graph of AVC and SMC (graph 1). In graph 2, quantity on x-axis is measured in hundreds of units. The firm will produce when the grey line(SMC) goes above the blue line(AVC), which is at 300 units.

Graph 2

5. Yes, the choices are the same. As dicussed, The producer will not produce below AVC because if he does there is not going to be only a fixed cost but also a loss on each unit that he produces, so he will shut down below AVC. He will produce 300 units according to this. As per table, the highest profit margin is also at 300 units.