You recently started a manufacturing business. You have done well enough to open

Question

You recently started a manufacturing business. You have done well enough to open two factories, one in Indiana and one in Wisconsin. You estimate that manufacturing 500 units will maximize your profit. At the moment, you are manufacturing 200 units in Indiana and 300 units in Wisconsin. At this output, the last unit of output in Indiana increased total cost by $5 and the last unit of output in Wisconsin increased total cost by $3.

a. Are you maximizing profit? Why? If not, what should you do?

b. If the firm produces 201 units in Indiana and 299 in Wisconsin, how much will your total cost increase (or decrease)?

Explanation / Answer

We are not maximizing profit because the marginal cost on the last output produced is not same in both the locations. Equi marginal principle states that the marginal cost of producing one additional output unit should be same across all the locations. Since the last unit of output in Indiana has a marginal cost of $5 which is higher than the marginal cost in Wisconsin, output should be produced more in Wisconsin and should be reduced in Indiana. This will bring the marginal cost in both the locations close to each other.

If Indiana starts producing one more unit then the total cost will increase by less than $5 and if Wisconsin is start producing one unit less, then the total cost in Wisconsin will increase by more than $3. This is because Wisconsin is more productive at this stage then Indiana.

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