Microecon
Financing in the Manufacturing Sector
50,000 workers = 200,000 units
Avg. wage = $80/day
Output price = $25/unit
Other variable costs = $400,000
Total Variable Costs = 50,000 x $80 + $400,000 = $4,400,000
Average Variable Costs = $4,400,000/200,000 = $
Average Total Costs = ($4,400,000 + $1,000,000)/200,000 = $
or ($4,400,000 + $3,000,000)/200,000 = $
Worker Productivity = 200,000/50,000 = 4
With $1,000,000/day in fixed costs at current output and productivity levels, the firm is operating at a loss of $2/unit, or $400,000/day. At $3,000,000 in fixed costs, the loss climbs to $12/unit or $2,400,000/day. Variable costs are covered in both scenarios.
Generally speaking, firms will only go into immediate shutdown when their revenue from production will not even cover the variable costs of that production — when the loss would be greater by producing units than by ceasing production altogether (Bade & Parkin 2009). As the variable costs are covered by revenue regardless of which fixed-cost scenario is examined, it is not immediately necessary for a shutdown of the firm, however costs must be controlled somehow.
In order to break even at current daily output levels (200,000 units) and prices ($25/units), assuming that other variable costs could not be changed and fixed costs of $1,000,000/day were also unalterable, the firm would need to lay off 5,000 workers (at $1,000,000/day in fixed costs, daily losses for the firm are $400,000; $400,000 divided by the $80 average daily wage of workers = 5,000). This means that 45,000 workers would need to produce the same 200,000 units, increasing productivity to 4.45 (200,000/45,000 = 4.44444 ). This is not a significant increase over the current productivity level of 4, meaning that it is entirely feasible for the firm to end its losses and potentially create real profit by increasing productivity and eliminating unnecessary workers (Bade & Parkin 2009). If productivity could be increased by one whole unit per worker per day, to 5 instead of 4, the company could lay off 10,000 workers, lowering the total variable cost per unit significantly and creating a profit for the company. If fixed costs are raised to $3,000,000/day, however, the lay-off number to break even becomes to large, and the firm should shut down.
Reference
Bade, R. & Parkin, M. (2009). Foundations of Microeconomics, 4th ed. New York:
Pearson.
