Honest Sam\'s Auto\'s Sam\'s Auto\'s faces a strategic managerial decision. The

Question

Honest Sam's Auto's

Sam's Auto's faces a strategic managerial decision. The firm can sell cars by simply posting a price. If the customer is willing to buy, clerks fill-out paperwork and the sale is complete. Alternatively, it can hire commissioned sales reps to probe customers willingness and ability to pay. (These reps are trained to ask customers where they live and work and often directly ask customers what they intend to spend!).

Under the former strategy, the firm's MC is $2 (thousand) per unit (which is also the AVC). The latter strategy increases MC and AVC by $1 thousand per car (to $3) but FC are $5 per month regardless. Under this approach, each customer essentially pays their full reservation price (willingness to pay). With a demand curve of P = 12 - Q, which strategy should Honest Sam's use and why?

Explanation / Answer

We should calculate MR

Total Revenue = TR = P*Q = (12-Q)*Q = 12Q - Q^2

MR = d TR / dQ = 12 - 2Q

For Former

MR = MC gives

12- 2Q = 2

Q = (12-2)/2 = 5

so Total Revenue = 12*Q - Q^2 = 12*5 - 5^2 = 35

For Later

MR = MC gives

12- 2Q = 3

9 = 2Q

Q= 4.5

TR = 12*4.5 - 4.5^2 = 33.75

Now In former case TR is gretaer than in later case also in Former case the total cost (Variable+ fixed) would be less

so profit will be greater.

He should go with former case

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