Reference no: EM132604898

Your friends X and Y have a small dry-cleaning service business. They have so many competitors that they cannot charge more than $5 per garment. Their total fixed cost is $140 a week.

X, the production manager, currently employs 50 workers with a weekly wage rate $35 and completes the cleaning of 500 garments per week. X shared with you that he has just received a few orders from Y, a manager of the sales and marketing department: 600 garments for next week and 700 garments for the week following next week. In order to produce more, X is employing more workers for his production department, 14 more workers for next week and 17 more workers for the week after.

Assume labour is the only variable cost of the firm and wage rate is constant.

1. Calculate the current output levels and those of each of the coming 2 weeks

2. X argues that their business should not serve more than 500 garments a week due to increased production costs, whereas Y favor continuously push up sales, arguing that they do not have any pricing power and can only generate revenues from the quantity of cleaning. Who do you support? Should they serve more than the current output level? Which is the optimal output for them to maximize profit?. 

3. 'The market price for dry-cleaning services is predicted to fall to $3.75 a garment in the foreseeable future. If the production and cost structures in our business remained the same at 500 garments a week, should we shut down our business right away or still operate for short run?'

4. 'Our total fixed cost is made up entirely of rent on the shop. Our lease on the shop runs out at the end of the year. If the market price is expected to stay at $3.75 a garment and the production and cost figures are expected to remain the same at 500 garments, should we renew our lease and continue this service business?'

5. It is also found out that recently our competitors are upgrading some new kinds of dry-cleaning machines, which may help fast drying, cleaning more garments with the same or even less labor. The new machines is advanced with so-called "green-dry system", which is a new detergent-free dry cleaning system, being capable in causing less greying and therefore more hygienic and no damage to garments. Our customers may like this green-dry with the higher quality features. However, the new green-drying machines are so expensive; additionally, the investments in this machinery may require additional costs for building a closed system of waste disposal and maintenance. X is proposing to buy the new machines. But Y is arguing that the competition in the market is higher with more pressure on price to fall and he believes the investments in machinery may not help the firm's revenue generation. Y argues that the profitability of this kind of business is likely to decrease; therefore, he suggests to quit doing this business".

What will you correctly reply to your friends regarding to their questions? Who is the correct: X or Y? Explain your answers by the emphasis on the role of the machinery investments for the firm's economic profit in long-run? Give a hint for the provision of a meaningful graph.