Chapter 5: Analyzing Managerial Decisions: Rich Manufacturing

Topics: Economics, Marginal cost, Costs Pages: 2 (685 words) Published: November 23, 2013
Case: Analyzing Managerial Decisions: Rich Manufacturing
Writing Task:
1.Why do many firms use cost-plus for supply contracts?
2.What potential problems do you envision with cost-plus pricing? 3.Should Gina contest the price increase? Explain.
4.Is the increase more likely to be justified in the short run or the long run? Explain. 5.How will a $3 increase in the price of machine parts affect Gina’s own production decisions?

Why do many firms use cost-plus for supply contracts?
“Firms that use the technique calculate the total cost and then mark up the price to yield a target rate of return” (Brickley et al, 2009, p 211). “Often information on marginal revenue and marginal cost is difficult to obtain with precision, making it impossible to exactly determine the point of profit maximization. By using cost-plus pricing, you can simply include a desired rate of return in the mark-up” (Graham, 2013). The primary purpose is so highly used by firms is the ease. You do not have to be as accurate with your estimates, and you need to have knowledge of the market. Knowledge of the market will lead to the appropriate requirement for the actual cost of the product.

What potential problems do you envision with cost-plus pricing? The potential problem with “cost-plus pricing is it focuses on average rather than marginal cost. Because profit maximization requires marginal cost equals marginal revenue, cost-plus pricing may not result in profit maximization” (Graham, 2013, p 238). The main reason a company is in business is to make a profit, and if you miss the market you will not make money. Cost-Plus does not focus on demand, and this could result in an excess surplus of goods.

Should Gina contest the price increase? Explain.
Gina should contest the price increase. Rich Manufacturing has a contract with a $5 mark up for cost-plus pricing. This increase is Bharat Incorporated labor cost and not at Rich Manufacturing. Bhagat Incorporated’s costs are...

References: Brickley, J., Smith, C., & Zimmerman, J. (2009). Managerial Economics and Organizational
Architecture (5th ed.). New York: McGraw Hill
Graham, R (2013). Managerial Economics for Dummies. (1st Edition) Hoboken, New
Jersey: Wiley
Graham, R (2013). Managerial Economics for Dummies. (1st Edition) Retrieved on November 3,
2013 from http://www.dummies.com/how-to/content/how-to-use-costplus-pricing-in-managerial-economic.html
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