6. Arrow now sells 100,000 silk shirts at $100 each. The material per shirt cost

Question

6. Arrow now sells 100,000 silk shirts at $100 each. The material per shirt costs $40 and labor costs are $50 per shirt. The firm has $1.2m. in fixed costs. Price elasticity of demand for such shirts is -4. The firm is considering lowering the price by 20% to $80. At the higher output, labor cost per shirt is expected to drop by 22% and the raw material supplier will offer a 15% discount on materials.
a. What is the profit position of the firm at the moment?
b. Would you advise the firm to cut prices? Why?

Explanation / Answer

a. Current profit =100,000*($100 - 40-50) -1.2*1000000 =-$200,000 b. % change in price =(80-100)/100=-0.2 % change in quantity/% change in price = -4 % change in quantity =-4 *-0.2 =80.00% (d-100000)/100000 = 80% d= 180000 new labor cost = $50*(1-22%) =$39 new raw material cost =40*(1-15%)=34 New profit =180000*(80-39-34) -1.2*1000000 = $60,000.00 Profit has become positive. I would advice the company to cut prices

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