Suppose that a paper mill “feeds” a downstream box mill. For the downstream mill
ID: 1165115 • Letter: S
Question
Suppose that a paper mill “feeds” a downstream box mill. For the downstream mill, the marginal profitability of producing boxes declines with volume. For example, the first unit of boxes increases earnings by $40, the second by $36, the third by $32, and so on, until the tenth unit increases profit by just $4.
The cost the upstream mill incurs for producing enough paper (one “unit” of paper) to make one unit of boxes is $12.50.
Assume the two mills operate as separate profit centers, and the paper mill sets the price of paper. It follows that the marginal profitability of boxes represents the highest price that the box division would be willing to pay the paper division for boxes.. Furthermore, assume that fixed costs are $0 for the paper mill.
The following table summarizes the quantity, total revenue, and marginal costs from the perspective of the paper mill for selling paper to the box mill at various prices.
In the following table, fill in the marginal revenue, total cost, and total profit for the paper mill when selling paper to the box mill at each given price.
Price
Quantity
Total Revenue
Marginal revenue
Total Cost
Marginal Cost
Profit
(Marginal Profitability to the Box Mill)
(Units of Paper equivalent to One Box)
($)
($)
($)
($)
($)
($)
If the paper mill sets the price of paper to sell to the box mill, it will set a price of ___ and sell___ units of paper to the box mill. Profits will befor the paper mill. Companywide profits will be___. (Hint: Recall that the prices in the table represent the marginal profitability of each unit of paper, or box, to the box mill.)
Suppose the paper mill is forced to transfer paper to the box mill at marginal cost ($12.50).
In this case, the box mill will demand___ units of paper. This leads to companywide profits of___.
Price
Quantity
Total Revenue
Marginal revenue
Total Cost
Marginal Cost
Profit
(Marginal Profitability to the Box Mill)
(Units of Paper equivalent to One Box)
($)
($)
($)
($)
($)
($)
$40 1 $40 ___ $12.50 ___ ___ $12.50 $36 2 $72 ___ ___ ___ $12.50 $32 3 $96 ___ ___ ___ $12.50 $28 4 $112 ___ ___ ___ $12.50 $24 5 $120 ___ ___ ___ $12.50 $20 6 $120 ___ ___ ___ $12.50 $16 7 $112 ___ ___ ___ $12.50 $12 8 $96 ___ ___ ___ $12.50 $8 9 $72 ___ ___ ___ $12.50 $4 10 $40 ___ ___ ___Explanation / Answer
If the paper mill sets the price of paper to sell to the box mill, it will set a price of $28 and sell 4 units of paper to the box mill. Profits will befor the paper mill. Companywide profits will be ($40 + $36 + $32 + $28) - 4*12.5 = $86
Suppose the paper mill is forced to transfer paper to the box mill at marginal cost ($12.50). In this case, the box mill will demand 7 units of paper. This leads to companywide profits of ($40 + $36 + $32 + $28 + $24 + $20 + $16) - 7*12.5 = 108.5.
Price Quantity Total revenue Marginal revenue Total cost Marginal cost Profit $40 1 $40 40 $12.50 $12.50 27.5 $36 2 $72 32 $12.50 $12.50 47 $32 3 $96 24 $12.50 $12.50 58.5 $28 4 $112 16 $12.50 $12.50 62 $24 5 $120 8 $12.50 $12.50 57.5 $20 6 $120 0 $12.50 $12.50 45 $16 7 $112 -8 $12.50 $12.50 24.5 $12 8 $96 -16 $12.50 $12.50 -4 $8 9 $72 -24 $12.50 $12.50 -40.5 $4 10 $40 -32 $12.50 $12.50 -85Related Questions
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