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Week 6 Assignment 2
Operations Decision By Earnest Lee Sims
November 16, 2014
Assignment 2: Operations Decision Eco 550 The purpose of this paper is to present the low-calorie microwaveable foods’ in support of the company’s long run operations decision plans. In the paper, I will examining the results of the new supply curve as it reflects to the current market structure and then take into account the expected changes to the selling environment and factors that may have caused the change. I will also examine chief short-run and long-run production and cost functions as applied to this new cost data to determine if there are conditions under which operations could be discontinued. Given the change in the market structure they we be a need to review the pricing structure so as to maximize profits. Finally, I will proposes two (2) course of actions that the company should take to increase profitability and maximize shareholder’s value. 1. The effectiveness of the market structure the company is operating. Every company in a pure competitive market is a price taker; the equilibrium price and industry output are is a direct result of demand and supply. “The market for low-calorie microwavable food” shows how demand and supply in the market for low calorie foods, produced under conditions of perfect competition, determine the total output and price consumers are willing to pay. The equilibrium price is 407.65 cents; the equilibrium quantity is 24,335. QD = 65,100 -100P Qs = -7909.89 +79.0989P. Firm operating in a pure competitive selling environment has no direct say on what the firm charges on its product, however, the firm can control the quantity supply to the market. According to Slack & Lewis, success or failure depends in a pure competitive market lies in how a company controls production cost and portrays its brand (2008). In pick out the capacity of
output, one significant concern is the income the firm will gain by manufacturing the products. The organization must develop ways of carrying out operations to ensure maximum revenue and increase productivity in the long run. According to Routledge, a good strategy is crucial in defining the effectiveness of the market structure in which the firm functions (2008). Bragg also reiterated by stating that a good market strategy will mostly emphasis on the products available for sale, the total number of companies participating, trends in pricing and important techniques of product promotion (2012). 2. Changes to market structure and reasons that have caused changes from the market structure specified in Assignment 1. Recent market surveys confirmed changes to the market structure from a perfectly competitive market to an imperfectly market structure. Imperfectly competitive market structures are markets where firms have the power to influence or determine price. A physical count of competing firms in the market revealed that they are now only fifteen companies directly compete for the market share of the low-calorie microwavable foods, of the fifteen on three companies control seventy five percent of the market share. Based on sells, our company is ranked as number two with a twenty-seven percent of sales of low-calorie microwavable dinners. The percentage market share represent the market concentration ratio. Beck, Demirguc-Kunt, and Levine (2003) defined concentration ratio as a measures of the collective market share the top number firms possesses in an industry. Given the above mentioned information, it is safe to conclude that we are now operating in an oligopolistic market structure. An oligopoly selling environment is a competitive market structure with moderately small numbers of businesses offering comparable products or services
(McGuigan, Moyer & Harris, 2014). The key cause of the market structure as pointed out by Slack & Lewis are withdrawal of a competitor and a major increase or decrease in the price of products (2003). The above changes influence business operations in various ways. For instance, there will be increased output since the market share increases resulting in an increase to cost of operations, with notable increases affecting elements such as labor, and advertisement costs. It is probable that labor costs will decrease in the long run as the firm’s control of new companies is solidified and redundant positions are deleted. The above changes may also require the company to upgrade its operations and embrace the use of modern technology in its operations (Bragg, 2012). 3. Short and long-run production and cost functions for the frozen, low-calorie microwaveable food company. TC = 160,000,000 + 100Q + 0.0063212Q2 VC = 100Q + 0.0063212Q2 MC= 100 + 0.0126424Q From assignment 1 QD = 350,000 -100 P QS = -7909.89 + 79.0989P ATC = TC/Q = (160,000,000/Q) + (100Q + 0.0063212Q2)/Q = (160,000,000/Q) + 100 + 0.0063212Q AFC = 160, 000, 000/Q AVC = 100 + 0.0063212Q To find the level of output that would minimize the average total cost, we have to equate the average total cost to marginal cost.
ATC = MC (160,000,000/Q) + 100 + 0.0063212Q = 100 + 0.0126424Q 160,000,000/Q = 0.0063212Q 160,000,000 = 0.0063212Q2 159,096.35 = Q Therefore, the value of Q which is 159,096.35 represent the output level that minimize the average total cost. In the short run, if production=n level equals 159,096.36 then we would be producing at our optimal average total cost. To find out how much it will cost to produce at our minimum average total cost:ATC = (160,000,000/Q) + 100 + 0.0063212Q = (160,000,000/159,096.35) + 100 + 0.0063212(159,096.35) = 1,005.68 + 100 + 1,005.68 = 2,111.36 = $21.11 This gives us our per-unit cost of production when we are at our most efficient level. In the long run if the selling environment changes and becomes competitive we will be forced to produce at our minimum total average cost. 4. Circumstances under which a firm should cease operations. The graph below demonstrations the correlation between average total cost (ATC), average variable cost (AVC), and marginal costs (MC). The MC curve intersects the ATC and AVC curves at their lowest points. Consequently, when MC is below an AVC, average cost is declining, and when MC is above average cost, average cost is rising. MC is the cost of manufacturing the last unit of output. MC curve increases with the quantity of output and the MC curve crosses both the ATC and AVC curves from below at their minimum points and moves
above. The shape of the MC curve branches from the Law of Diminishing Returns. Diminishing returns in the most rudimentary sense arises when marginal product cascades as a growing amount of a variable similar input is applied to a fixed input (Blaug, 1985). The shutdown point is the point where minimum average variable cost (AVC) intersect the marginal cost (MC). If the price falls below the minimum point b in the graph, then we should shut down. This means that the company can circumvent making further losses by suspending operations. In the long run the company should close its operations if it’s making economic losses -- unless changes could be implemented that can allow the firm to adjust its scale and curb those losses (Scotchmer 1991). This might be achieved by shifting production to a different SRATC curve via a different capital choice. The breakeven point is a point where marginal cost intersect the average total cost. However, if the market price fall below $21.11, depicted by point C in the graph, and above point be we have to continue operations in the short run. This is because prices at least covers our variable cost and some of the fixed cost. However, in the long run under competitive environment, the company have to exist the industry. As reiterated by Stokes, management have to play an active in dealing with the market conditions, placing market research personnel and being on the frontline dealing with market prices (Stokes, 2008). 5. The pricing policy that will allow frozen, low-calorie microwavable food company to capitalize on profits. For profit maximization, I propose the use of the cost profit maximization rule where marginal revenue is equated to marginal costs. This is a process whereby the company determines the best output and price levels in order to maximize its return (Scotchmer, 1991). The point depicted by
quantity q*is where the MR and MC curves converge. The price that correspond to quantity is then found by extending q* up to the demand curve to get p*. No any other price will work because a higher price will shrink sales below q*, and a lower price will rise sales above q*. Given the demand function of, QD = 350,000 -100 P, we need to find the Inverse Demand function: - 100P = 350,000 - Q P= (350,000/100) - Q/100 = 3,500 - 0.01Q Total Revenue (TR) = P*Q = (3,500 – 0.01Q)*Q = 3,500Q – 0.01 Q2 MR = TR/Q = 3500-0.02Q Therefore, to maximize earnings marginal revenue have to be equated to marginal cost. MR = MC 3,500 - 0.02 Q = 100 + 0.0126424 Q 3,400 = 0.0326424Q 104,159.01 = Q Q represent the profit maximizing output which is well below the output at the minimum average total output. To get the price that we can charge at this output to maximize our profit, we substitute the quantity in the profit equation the:P = 3,500 - 0.01Q = 3,500 - 0.01Q (104,159.01)
= 2,458.41 = $ 24.58 6. To evaluate its financial performance. From the calculation above, the production combination of 104,159.01units and selling price of $24.58 per unit puts us at the top of our profit function. Because we have some market power, this combination puts us in the elastic part of the demand curve. Any price hikes will result in market share loss and price reduction results higher profit realization. To evaluate our current financial performance at a production quantity of 104,159.01 units ATC = (160,000,000/Q) + 100 + 0.0063212Q 160,000,000/104,159.01+ 100+ 0.0063212(104,159.01) 2,294.52 = $22.95 We are selling are products at $24.58 yet it cost us $22.95 to produce giving us a profit of $1.63 per unit. This is an economic profit. Our short run profit would be T R - TC TR = P * Q $24.58 * 104,159.01 $2,560,228.47 TC = ATC * Q $22.95 * 104,159.01 $2,390,449.28 Profit = $2,560,228.47 - $2,390,449.28 $169,779.19 7. Two (2) ways the firm can improve profitability and deliver more value to its stakeholders. The biggest costs to the company have included fuel (always climbing), energy and raw materials. While the company has expanded its business through product innovation, its fixed
and variable continue to climb. The company needs to look at ways to reduce its fuel costs and well as its costs of raw materials and its packaging costs. To reduce fuel costs it needs to consider a directed dispatch system and organized routes based on scheduled commercial sales and orders made online by individual consumers. They may want to look at additional distribution channels outside of their system. As they already handle orders by individual consumers, they need to consider moving into direct-to-consumer sales possible as fund raiser for schools, day cares, and other such organizations. They also need to consider methods of reducing their packing related costs whether it be conversion to cryogenic freezing or better packing methods. It may also help if the company develops and presents food materials on a rotational basis to keep people interested in their products. The company needs to involve its employees in identifying reducible costs and methods of doing so. References Beck, T., A. Demirguc-Kunt, and R. Levine. 2003. “Bank Concentration and Crises.” NBER Working Paper no. 9921, August. Blaug, M., (1985). Economic Theory in Retrospect, 4th edition. Cambridge: Cambridge University Press, Bragg, M. S., (2012). Financial Analysis: A Controller's Guide. (2nd Ed.). John Wiley & Sons. McGuigan, J., Moyer, R. & Harris, F. (2014). Managerial Economics: Applications, Strategies, and Tactics (13th Ed.). Cengage Learning. Mason, Ohio. Routledge. S., D. (2008). Principles and Practice of Variable Pressure/Environmental Scanning Electron Microscopy. John Wiley and Sons
Scotchmer, S. (1991), Standing on the Shoulders of Giants: Cumulative Research and the Patent Law, Journal of Economic Perspectives, 5. Slack, N. & Lewis, M. (2003). Operations Management: Critical Perspectives on Business and Management.