1. Consider a copy shop with annualized fixed costs of $1000 and variable cost of $0.03 per page. The shop presently has orders for 100,000 copies at a price of $0.05 per page. A new customer approach the shop with an order of 10,000 copies, but will pay only $0.035 per page.

(a) What is the shop’s average cost (AC) without taking the new order? Is it less than the product price?

(b) What is the shop’s average cost (AC) if it does take this order? Is it less than or greater than the price for the new order? Should this be the criteria for deciding whether to take the new order?

(c) If not, what is the appropriate criteria for taking the order? Explain.

2. Suppose you own a specialized auto parts manufacturer. You purchase and have installed a new machine to make a particular type of part. The price of the machine plus installation is $300,000. Once the machine is purchased and installed it has no resale value, but it does not wear out. Other costs of making the parts are $200 per unit.

Suppose you are able to make and sell 1000 units at $225 each. Let the market rate of interest be 10%.

(a) If you have already purchased the machine, should you go ahead and make and sell the 1000 units or should you close your operation?

(b) If you have not yet purchased the machine and anticipate selling only 1000 at a price of $225, should purchase the machine and produce?

(c) Is there a difference in your answers to (a) and (b)? Explain.