For Two Years Annette Larson Has Been the Manager of the Production

question 184

Essay

For two years Annette Larson has been the manager of the production department of a company manufacturing toys made of plastic-coated cardboard. One of the toys is a paper doll whose "clothes" are made of acetate and stay on the doll with static electricity. The company's sales were mainly to large educational institutions until last year when the dolls were sold for the first time to a large discount retailer. The dolls were sold out immediately and enough orders were received to keep the department at full capacity for the immediate future.
The fixed costs for the department are $50000 with $1 per unit variable costs. A paper doll and one set of clothes sell for $3. The maximum volume is 80000 units. With the increased volume Ms. Larson is considering two options to improve profitability. One would reduce variable costs to $0.75 and the other would reduce fixed costs to $35000.
Required:
Given the fact that sales are increasing make a short (one paragraph) recommendation to Ms. Larson about which option she should choose. Support your recommendation with a calculation showing her how profitability will change with each option.

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Definitions:

Short-Run Average Total Cost

Short-run average total cost is the total cost of production (fixed and variable costs) divided by the total output produced, calculated when at least one factor of production is fixed.

Economies

The large set of interrelated production and consumption activities that aid in determining how scarce resources are allocated.

Diseconomies

Circumstances where increasing the scale of production leads to higher per-unit costs, often due to inefficiencies gained at larger scales.

Average Total Costs

The average cost per unit is calculated by dividing the entire production cost by the quantity of units produced.