Economics - Mcost
A retail dry cleaning store cleans two-piece suits for $12 each. Its patrons are individual "walk-ins." There are several similar dry cleaners in the city and this firm offers no special services. The firm can clean up to 1,000 suits per week. It has fixed costs of $3,500 per week (amortization on its equipment, rent, taxes, and salaries) plus a cost of $4 per suit for chemicals, packaging materials, order processing, and incidentals. Volume per week has been fairly constant at 600 suits.
A firm that operates three hotels in the city is asking the store to clean 150 two-piece staff uniforms per week at a price of $6.75 per suit. The process would be the same as the store uses on suits. Because there are several dry cleaning stores available to the hotel operator, it will not negotiate its offered price. The store has sufficient capacity to do this work as it has excess capacity of 400 (= 1,000 - 600) suits at this time and the special job calls for cleaning 150 suits.
1. Should the hotel chain's offer be accepted by the dry cleaning store at the special price for this job of $6.75? Briefly justify your decision, showing the results of any calculations you made in support of your answer.
The offer should be accepted by the dry cleaning service. The reason is that the dry cleaning company is in a perfectly competitive market since “there are several similar dry cleaners in the city and this firm offers no special services”. Even though the dry cleaning company is receiving less in price than what they normally charge ($6.75 per suit rather than the market price of $12.00). The hotel uniforms will increase revenue by $1012.50 ($6.75*150), whereas the increase to costs will only be $600 ($4.00*150). To maximize profits, a perfectly competitive firm with excess capacity produces the output at which price equals marginal cost. In this case, the price of $6.75 is still greater than their marginal cost at $4.00. The dry cleaning service would be better off taking
A firm that operates three hotels in the city is asking the store to clean 150 two-piece staff uniforms per week at a price of $6.75 per suit. The process would be the same as the store uses on suits. Because there are several dry cleaning stores available to the hotel operator, it will not negotiate its offered price. The store has sufficient capacity to do this work as it has excess capacity of 400 (= 1,000 - 600) suits at this time and the special job calls for cleaning 150 suits.
1. Should the hotel chain's offer be accepted by the dry cleaning store at the special price for this job of $6.75? Briefly justify your decision, showing the results of any calculations you made in support of your answer.
The offer should be accepted by the dry cleaning service. The reason is that the dry cleaning company is in a perfectly competitive market since “there are several similar dry cleaners in the city and this firm offers no special services”. Even though the dry cleaning company is receiving less in price than what they normally charge ($6.75 per suit rather than the market price of $12.00). The hotel uniforms will increase revenue by $1012.50 ($6.75*150), whereas the increase to costs will only be $600 ($4.00*150). To maximize profits, a perfectly competitive firm with excess capacity produces the output at which price equals marginal cost. In this case, the price of $6.75 is still greater than their marginal cost at $4.00. The dry cleaning service would be better off taking