You are a newspaper publisher. You are in the middle of a one-year rental contract for your factory that requires you to pay $400,000 per month, and you have contractual labor obligations of $1 million per month that you can't get out of. You also have a marginal delivery cost of $.10 per paper. If sales fall by 20 percent from 1 million papers per month to 800,000 papers per month, what happens to the AFC per paper, the MC per paper, and the minimum amount that you must charge to break even on these costs?
Feedback: Consider the following example. You are in the middle of a one-year rental contract for your factory that requires you to pay $500,000 per month, and you have contractual labor obligations of $1 million per month that you can't get out of. You also have a marginal printing cost of $.25 per paper as well as a marginal delivery cost of $.10 per paper. Now assume sales fall by 20 percent from 1 million papers per month to 800,000 papers per month.
Here Marginal Cost (MC) is Constant, which implies that Average Variable Cost (AVC) is constant and equals MC. This does not imply Average Total Cost (ATC) is constant or has to equal MC. Total Cost (TC) = Fixed Cost (FC) + Variable Cost (VC)
Divide through by the quantity Q, which implies TC/Q = FC/Q + VC/Q.
This gives us ATC = AFC + AVC.
Now, since MC is constant (each unit of output costs MC to produce) , thus we have MCxQ = Variable Cost (VC). Note this is variable cost (VC) because we do not have to produce.
Divide this by Q, which implies that MC = VC/Q = AVC
Substituting this result into the ATC equation, we have ATC = AFC + MC (or AVC).
Thus, MC and AVC are the same in this set-up.
To break-even before the decline in sales, the company needed to charge enough to cover the AFC,, and the average variable cost (AVC) (This is the sum of the printing cost and delivery cost per paper). Thus, the company needed to charge $???? per paper.
To break-even after the decline in sales, the company needs to charge enough to cover the AFC, ???, and the average variable cost (AVC) of $??? (This is the sum of the printing cost and delivery cost per paper, note this does not change because the cost is per paper). Thus, the company needed to charge $???? per paper.
Facts:
1. Middle of one-year rental contract at $400,000 per month with labor at $1 million per month.
2. Marginal delivery cost at $.10 cents per paper
Question:
1. If sales decrease 20% (1 million to 800,000 per month )
a. What is cost of AFC per paper?
b. What is MC per paper?
c. What is minimum amount must charge to break even on costs?