Question

Suppose that there are two firms operating in a market.  Suppose that the degree of operating leverage for Firm 1 is DOL= 1.5 while the degree of operating leverage for Firm 2 is DOL=2

1. How much would the profits of each firm change if both firms experienced an increase in quantity sold of 10%?
2. Suppose instead that each firm experiences a 5% decrease in quantity sold.  What would happen to the profits of each firm?
3. Which firm’s profits are more sensitive to changes in output?  Why?

Answer 1

DOL = 1.5 Inswer page: 01 Given Suppose that the degree of operating leverage for firm i is firm 2 is DOL = 0. (a) How much would the poo bits of each firm change of both fioms experienced an increase in quantity Sold to DOL = . change in cooning before tar I change in sales, Fo DOL I = 1.5 1. This imply to change in earning before tax (profit) = 1.54x change in sales. change in profit = 1,5x101. = 115.7.) For DOL2 = 9; percentage change in porning (profit) - axlchange in quantity = 2x10'l. 20:12 (b) what would happen to the profits & coun fino % change in quantity = -5%. For from i; profit fall by 1.5x (-5:1) = 7.5% for from a profit fall by aX (-5/12 = 10% c) which ligon's profits are more sensitive to changes in output from a] is more sensitive to changes in output This is because of higher degree of operating leverage and while Explanations