Question

Consider the problem facing two firms in the fast-food restaurant market, Firm A and Firm B. Each company has just come up with an idea for a new fast-food menu item, which it would sell for $6. Assume that the marginal cost for each new menu item is a constant $2 and the only fixed cost is for advertising. Each company knows that if it spends $12 million on advertising, it will get 2 million consumers to try its new product. Firm A has done market research which suggests that its product does not have any staying power in the market. Even though it could get 2 million consumers to buy the product once, it is unlikely that they will continue to buy the product in the future. Firm B's market research suggests that its product is very good, and consumers who try the product will continue to be consumers over the ensuing year. On the basis of its market research, Firm B estimates that its initial 2 million customers will buy one unit of the product each month in the coming year, for a total of 24 million units. Refer to Scenario 16-2. If Firm B decides to advertise its product, what can it expect to happen? (0) It will incur a loss of $36 million per year. O It will have a profit of $96 million per year. It will have a profit of $84 million per year. It will exit the industry.

Answer 1

Solution. Answer For firm - B ontotoshoot Total units expected to o Price of one unit sell = 24 million = $6 Total Revenue - 24x6 =$144 Million - Marginal cost per unit - $2 Total variable Cost of 24 a Million Units = 24x2 = $48 Million Fixed Cost (Advertising) = $12 Million Totol Cost of 24 Million Units - 48+ 12 Profit = = Total Revenue - Total Cost 14u - to - $84 Million per year