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You are a newspaper publisher. 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 marginal delivery cost of $.10 per paper. If sales fall by 20% 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 chager to break even on these costs?

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Answer:

  • The AFC changes from 1.50 to 1.875. That's an increase of 0.375.
  • The MC remains constant at 0.35 because the printing and delivery costs per paper are unchanged.
  • The minimum amount that we must charge to break even increases from 1.85 to 2.225. That is an increase of 0.375.

Explanation:

The following are fixed costs:

Rent 500000/mo

Labor 1000000/mo

The following are variable costs:

Printing $0.25/paper

Delivery $0.10/paper

So, the fixed costs are 1500000/mo and the marginal cost is 0.35/paper.

AFC = FC/Q

At 1000000 papers,

AFC = 1500000/1000000

AFC = $1.50/mo

At 800000

AFC = 1500000/800000

AFC = $1.875/mo

MC = $0.35 per paper and does not change with the number of papers.

The minimum amount that we must charge to break even is average total cost.

ATC = AFC + AVC

ATC = FC/Q + VC/Q

VC = MC*Q

ATC = FC/Q + MC

ATC = FC/Q + 0.35

At Q = 1000000,

ATC = 1.50 + 0.35

ATC = $1.85

At Q = 800000

ATC = 1.875 + 0.35

ATC = $2.225

The AFC changes from 1.50 to 1.875. That's an increase of 0.375.

The MC remains constant at 0.35 because the printing and delivery costs per paper are unchanged.

The minimum amount that we must charge to break even increases from 1.85 to 2.225. That is an increase of 0.375.