Cost Analysis

Question

Company supply = 800 hand knit sweaters (Q)

Selling price = $150

 

Costs:

Mortgage = $1200 per month (4 weeks)

Utilities = $500 per month average

Taxes & Permits = $200 monthly payment

Materials = $20 per sweater (yarn, needed, thread, buttons)

Wages = $10 per hour regular shift; $15 per hour overtime (only use for #9)

Employee Benefit = $50 per worker per month (insurance, etc.)

 

Production Data:

- 50 full time employees

- all 50 employees work 40 hours every week (4 weeks)

- one sweater can be competed with 10 hours of labor

 

For the following questions I got only #1 right. I got $120,000. The rest I either got wrong or did not understand.

 

1. What is the expected total revenue assuming all 800 sweaters sell?

 

2. What is the total cost for this company to produce 800 sweaters? (add all six costs above)

 

3. What is the average cost per sweater?

 

4. What is the expected total profit?

 

5. What is the average profit or profit for sweater?

 

6. How many sweaters would be made by the addition of one fulltime worker? (marginal product)

 

7. What is the marginal cost of adding one additional fulltime worker for the entire month?

 

8. What will the market revenue product of labor (MRPL) and marginal profit per sweater be for selling these additional sweaters?

 

9. Now calculate how much it would cost to make these additional sweaters using overtime labor instead.

 

10. Would you advise using overtime labor instead? Explain.

Answer 1

First of all, according to my understanding, the answers should be for a month only since question 7 asks clearly the increase in MC by adding one fulltime worker for the entire month. Therefore, assuming the production of 800 sweaters is for a month, my answers are as follows:

 

1. You got it right. 

 

Total Revenue (TR) = Selling price × Q

                             = $150 × 800 = $120,000

 

 

2. Total Cost (TC) = Fixed Cost (FC) + Variable Cost (VC)

 

FC = Mortgage + Utilities + Taxes & Permits 

     = $1200 + $500 + $200 = $1900.

 

VC = Materials + Wages + Employee Benefits

 

Material Cost = Cost per sweater × Q

                       = $20 × 800 = $16,000

 

Wages = Cost of number of hours worked by one employee per month × Number of employees

 

Cost of number of hours worked by one employee per month is as follows:

 

1 employee works 40 hours per week.

 

1 employee works (40 hours × 4 weeks) = 160 hours per month ( since 4 weeks = 1 month)

 

1 employee gets 160 × $10 (since $10 per hour is the wage for regular shift) = $1600 per month.

 

Therefore, cost of number of hours worked by one employee per month is equal to $1600.

 

Wages = $1600 × 50 = $80,000

 

Employee Benefit = Cost per worker per month × Number of employees

                              = $50 × 50 = $2500.

 

Therefore VC = $16,000 + $80,000 + $2,500

                      = $ 98,500

 

Total Cost (TC) = $1,900 + $98,500 = $ 100,400

 

 

3. Average Cost (AC) = (Total Cost / Q)

                                    = ($100,400 / 800) = $125.5

 

 

4. Total Profit = TR - TC

                        = $120,000 - $100,400 = $19,600

 

 

5. Average Profit = Total profit / Q

                             = $19,600 / 800 = $24.5

 

 

6. Marginal Product = 

 

Since 10 hours of labor are required to knit one sweater, then 

160 hours (number of hours worked by one employee per month) of labor are required to knit (160 / 10) 16 sweaters.

 

Therefore, the MP = 16 sweaters

 

 

 

7. Marginal Cost = Increase in Total Cost by adding one more fulltime worker.

     The increase in TC will be brought about by change in VC component, since the FC component will remain unchanged.

 

Therefore MC = Increase in wages + Increase in employee benefits + increase in materials' cost

                       = $1,600 (wage for one employee per month as calculated above) + $50 (per employee per month)

                           + $320 ($20 × 16) (material cost per sweater × MP)

                       = $ 1,970.

 

 

 

8. MRPL = MP × Selling Price

               = 16 × $150 = $2,400

 

 

   Marginal Profit = MRPL - MC

                            = $2,400 - $1,970 = $430

 

 

 

 

9. New MC (with overtime) = Increase in wages + Increase in materials' cost (There will be no increase in                                                             employee benefits because we are not hiring a new employee but making one                                                           employee do overtime)

                                       

                                       = $2,400 (160 hours × $15) + $320 

                                       = $2,720.

 

 

 

10. No, i would not advise to use overtime labor because the MC with overtime labor is more than the MC with additional labor. This will result in less marginal profit with overtime labor as compared to marginal profit with additional labor, and no firm would like to decrease its profits.

 

 

I hope your queries are satisfied.