A retail dry cleaning store cleans two-piece suits for $12 each. Its patrons are individual "walk-ins." There are several similar dry cleaners in the city and this firm offers no special services. The firm can clean up to 1,000 suits per week. It has fixed costs of $3,500 per week (amortization on its equipment, rent, taxes, and salaries) plus a cost of $4 per suit for chemicals, packaging materials, order processing, and incidentals. Volume per week has been fairly constant at 600 suits.
A firm that operates three hotels in the city is asking the store to clean 150 two-piece staff uniforms per week at a price of $6.75 per suit. The process would be the same as the store uses on suits. Because there are several dry cleaning stores…show more content…
Why or why not?
The special job still should be accepted even if the hotel chain is only willing to pay $4.25 per uniform. As mentioned previously, the price at $4.25 is still greater than the Marginal Cost at $4.00 and therefore it is still profitable for the firm to continue and make the uniform. The increase in revenue would be $637.50 ($4.25*150), whereas the increase in costs would only be $600 ($400*150). Therefore, even though the $4.25 is far below the $12.00 market price and the average total cost of $8.67, it is still a profitable order.
Calculation below: =$4.25 =$4.00 =$8.67
3. Suppose the hotel chain is willing to negotiate the price. When you enter the negotiations, what is the lowest price you are willing to accept (i.e., your reservation price)? (Of course, you will not announce this price to the other party.)
Since this firm is in a perfectly competitive market, they must charge the same price in the industry to be competitive. Since they have excessive capacity of up to 400 suits above their normal sales, the incremental job allows them to negotiate a price anywhere revenue is greater than the variable cost per shirt. The lowest price that the dry cleaning service should accept is the point where the Market Price=Marginal Cost =Marginal Revenue, which is $4.00 per uniform. This is only the case because the dry cleaning service has the excess capacity and