Problem
Johnson Tricycle Manufacturers currently sells 20,000 tricycles per month at a price of $10 each. The firm's fixed costs are currently 60 percent of sales revenues. At the current level of production, the firm's average variable cost per tricycle is $4. The firm is just covering its total cost. The sales manager argues that a reduction in the price of tricycles to $9 would enable the firm to earn a monthly profit of $5000 as the result of increased sales. Since the firm has ample capacity, the necessary expansion in output could be accomplished without any increase in the average variable cost of tricycles.
a. Does the sales manager's argument make sense? Explain.
b. How much would sales have to increase in order for the firm to earn a monthly profit of $5,000? {Hint: Remember fixed costs will not vary with output.)
c. What price elasticity of demand is necessary for the sales manager's prediction to be realized?
The response should include a reference list. Double-space, using Times New Roman 12 pnt font, one-inch margins, and APA style of writing and citations.