|
In this first application we'll consider a pricing issue. Charlie's "skinflint nephew," Everett, has asked Charlie for a
special deal on a set of four dining room chairs. "Not a penny more than $175
each" was Everett's parting shot as Charlie hung up the phone after a
less-than-cordial conversation about how much the chairs were worth and what
sort of special favor Everett should get as a family member. Charlie is having a
hard time separating his emotional reaction to Everett's stinginess [long the
subject of family jokes] from an objective analysis of whether he can make
anything on the job or not.
Just describing the phone conversation gets Charlie going again, but after he
simmers down, he does explain that the 4 chairs sold to Everett would be outside
the arrangement with the dealer, so the commission would not apply.
Required:
- Strictly from an economic perspective, what issues are relevant in
this situation?
Answer
The most critical economic issue here is the matter of incremental costs.
The key question to ask is: What additional costs will Charlie incur IF he accepts the special order from
Everett? Charlie will incur all the usual variable costs, except the commission.
Total fixed costs per month will be the same, irrespective of Charlie's
decision. Therefore the fixed costs are irrelevant and can be ignored.
- What other
considerations are involved? Answer
There are several qualitative issues here. One is obviously the whole matter
of precedent. It appears that Everett has quite a reputation in the family. If
Charlie gives in this time, what will Everett want the next time he calls?
What about other family members? Will they want the same treatment? Acceptance
of the order could lead to a spiral of increasing demands for "even better"
deals. Alternatively, Charlie might want avoid offending Everett. He has to
weigh the risk of further requests for special arrangements like this against
the possibility of starting a family feud. However, it sounds as though
Everett is a sufficiently well-known quantity that Charlie can tell him to
take a hike without great risk.
Another issue is the potential existence of other work that will be more
profitable. Suppose Charlie figures he can turn out six chairs per month
without stressing, and he already has orders for 4 chairs. If the special deal
to Everett would cut into regular, more profitable business, then it obviously
isn't worth it.
- Based on your understanding of Charlie's incremental costs, should Charlie
accept the job or not?
Answer
Based solely on economic considerations, the incremental revenues of
$175/chair are greater than the incremental costs [50 + 90 + 13 + 9.50 =
162.50], for a contribution of $12.50/chair, or $50.00 on the whole job.
-
What is the minimum price Charlie can accept on this job without losing money?
Answer.
The minimum price is the total variable cost on the job, which is $162.50. At
a price less than this, Charlie will lose money. At a price greater than this,
he'll make money. However, it is important to note that this is a short run
focus. In the long run, Charlie has to cover all his costs.
| 
