Question

Question 4

Glee Cupcakes in Chelsea, Michigan bakes delicious gourmet cupcakes that are sold throughout southeast lower Michigan. Suppose that the gourmet cupcake market is a (perfectly) competitive business in this area, and so the owner of the bakery knows that it is important to keep costs under control.

At its current production level, Glee Cupcakes has given an MBA marketing team the following data estimates:

• Cupcake price: $4
• Quantity sold per week: 150
• Current marginal cost: $4
• Total variable cost per week = $650
• Average fixed cost: $50
• Glee's current production is very efficient and it is producing at the smallest AVC possible for its current quantity.

Based on this data, what is the best advice the MBA team can give Glee Cupcakes?

Group of answer choices

(a) You are already doing the best you can, given costs and price, so keep production at the same level.

(b) Increase your cupcake output to increase total revenue; you face an elastic demand curve, so the only way to increase your revenue is to sell more cupcakes.

(c) Decrease your cupcake output to decrease your total costs, then you can cover your operating expenses.

(d) Produce zero cupcakes. (Shut down, at least for now.)

(e) We need more information.

Answer 1

The case says that Glee is producing at the smallest AVC possible for its current quantity, but what's not clear is if the AVC will go up or down as production is increased. If the firm is operating in the increasing marginal cost area or the decreasing marginal cost area of the production curve.

At the current output, the firm is making losses since its cost is higher than revenue. Increasing output will lead to profits only if the firm is in decreasing marginal cost area (so that the marginal cost for output beyond 150 units will be lower than $4 and a selling price of $4 will lead to incremental profits, probably wiping out the losses).

On the other hand, if the firm is already in the increasign marginal cost of production phase, then it doesn't make sense to increase output. Output should be reduced in this case.