02 May Question: Exercise 10.7 Royersford Knitting Mills, Ltd., sells a line of women’s knit underwear. The firm n…
Exercise 10.7
Royersford Knitting Mills, Ltd., sells a line of women’s knit underwear. The firm now sells about 20,000 pairs a year at an average price of $40 each. Fixed costs amount to $240,000, and total variable costs equal $480,000. The production department has estimated that a 10 percent increase in output would not affect fixed costs but would reduce average variable cost by 40 cents.
The marketing department advocates a price reduction of 5 percent to increase sales, total revenues, and profits. The arc elasticity of demand with respect to prices is estimated at −2.
The proposal to cut prices by 5 percent would total revenues from $800,000 to
. Total costs would be
and total profits would be
.If average variable costs are assumed to remain constant over a 10 percent increase in output, total profits after a 5 percent price cut would be
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