GB540 Unit 10 Firm Economic Analysis Example

Three Prices, About 3,224 Motors and No Second Shift: A Unit 10 Firm Economic Analysis for an Outboard Maker

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Purdue University Global

GB540: Economics for Global Decision Makers

Unit 10 Firm Economic Analysis

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[Date]

Ruddiman Marine and every figure are composite and illustrative, carried from the earlier units of the course; the economics sources cited are real.

Executive Summary

Raise the US price from $4,400 to $4,600, move Australia from AUD 7,400 up to 7,740, and take Norway from NOK 49,900 up to 51,500. Plan about 3,224 motors. Meet that volume with a few weeks of overtime, and defer a second shift until orders pass about 4,770. Hedge one season of foreign revenue. The plan raises contribution from about $5.81 million to $5.92 million and operating profit from about $2.91 million to $3.02 million after $2.9 million of fixed cost.

1. Demand

Ruddiman Marine's US demand, estimated from 48 dealer-seasons in Unit 3, has an own-price elasticity of about minus 2.31 at the sample means, a cross-price elasticity with gasoline outboards of about 1.09 and an income elasticity of about 0.46. The Australian promotion in Unit 2 gave an elasticity of about minus 1.91 once growth in other states was netted out. Unit 1 established why the firm cannot read elasticity from raw market data: the market's price and quantity moved because both supply and demand shifted, and only Ruddiman's own price variation identifies its demand (Working, 1927).

The figure that drives pricing: the US price coefficient of minus 0.0745, which sets how many motors each $100 costs.

2. Cost

Unit 4 built the cost schedule. Fixed cost is $2.9 million a year, and straight-time variable cost $2,280 a motor up to 3,200 motors. Above that, overtime raises marginal cost, to $2,458 at 3,600. A second shift becomes cheaper than overtime near 4,770 motors.

The figure that drives output: marginal cost above 3,200, which rises about 12 cents with each motor.

3. Market Structure

Unit 5 found all three markets highly concentrated by the Herfindahl-Hirschman Index, but different in conduct. US electric outboards behave as a rivalrous oligopoly, US gasoline outboards as a coordinated oligopoly following a price leader, and Norwegian electric outboards as a dominant firm with a fringe. Concentration alone did not separate them, consistent with the finding of Bresnahan and Reiss (1991) that conduct changes little once a market has a few firms.

The figure that drives the Norwegian price: the leader's NOK 52,900.

4. Pricing

Unit 6 found Ruddiman's markups too small for its estimated elasticities. At $4,400 against a delivered cost of $2,998, the US markup would be optimal only if buyers were about a third more sensitive than the minus 2.31 estimate (Lerner, 1934). The linear demand curve put the US optimum at about $4,618, and the paper chose $4,600. Australia moved halfway to its computed optimum, to AUD 7,740, because its elasticity rests on one season. Norway moved to NOK 51,500, below the leader. All three prices, in dollars, sit within $700 of one another, the cost of moving a motor between markets.

5. Macro Conditions and Policy

Unit 7 translated six indicators into a plan of about 3,575 motors at current prices, with the largest cut in Norway, where confidence fell 6.4 points. Unit 8 found that the expected US rate rise matters mainly through a firmer dollar, worth about $196,800 in foreign revenue for a 3 percent move, while the effects on dealer carrying costs and consumer loan payments are small. A $750 state rebate in two states calls for no change beyond the national price increase.

The figure that drives the volume plan: Norwegian consumer confidence.

6. Currency Risk

Unit 9 found that a 10 percent weaker krone would cut Norwegian contribution by about $257,000 at current prices and that pricing just under the leader recovers only about $46,000 unless the leader also raises its price. In Australia, full pass-through of an 8 percent fall recovers about $93,000 of $315,000. A 5 percent stronger won adds $252,000 to the pack bill.

The figure that drives currency exposure: the Norwegian leader's response to its own euro costs.

The Plan

Held-price case. Current prices with the Unit 7 volume adjustments: 2,176 motors in the United States, 820 in Australia and 579 in Norway, about 3,575 in total. Contribution after all variable cost, including overtime on 375 motors, about $5.81 million. Operating profit about $2.91 million.

Recommended case. New prices with the same economic conditions. The US forecast falls to about 1,939 motors, from 137 to about 122 per dealer. Australia falls to about 748, using the elasticity of minus 1.91. Norway falls to about 537, using the US elasticity as a proxy. Total about 3,224. Contribution about $5.92 million. Operating profit about $3.02 million.

The plan sells about 350 fewer motors and earns more, because the motors it gives up were the ones sold below their worth and built on overtime.

Why output falls so far. Most of the drop comes from the United States, where the price rise moves sales along a fairly elastic demand curve. The lower volume also removes most of the overtime, so the cost of the last motor falls from about $2,455 at 3,575 motors to about $2,413 at 3,224.

Does the Lower Volume Change the Prices?

The prices in Unit 6 were set using marginal cost at 3,600 motors. At 3,224 motors, delivered marginal cost in the United States is about $2,953 rather than $2,998. Recomputing the linear optimum with the lower cost gives about $4,596, so $4,600 still holds. The plan is consistent with itself: the prices produce the volume, and the volume supports the prices.

The Second Shift

At 3,224 motors the plant needs only about 24 motors of overtime. Adding a second shift would mean $310,000 of fixed supervision cost and a $26 premium on each night motor, against overtime premium of about $3,200. The decision is clear for next season. It should be revisited if orders approach 4,770.

Risk Register

US elasticity higher than estimated. If buyers respond more strongly to price than minus 2.31 suggests, the US price rise will lose more volume than planned. Watch dealer sales in the first month and be ready to return to $4,400.

Chinese maker cuts price again. Rivalrous US conduct means a rival's cut could raise Ruddiman's effective elasticity. Respond with dealer promotions rather than a list price change.

Krone weakness. If the krone weakens, keep the Norwegian price below the leader's and wait for its next announcement before moving again.

Australian elasticity from one season. The halfway step limits the cost of an error. Review after the season.

Won strength. Forward cover on contracted packs limits one season's exposure; a second supplier priced in dollars would limit it longer.

Conclusion

Each decision in the plan follows from one figure estimated in an earlier unit: the price coefficient for pricing, marginal cost for output, the leader's price for Norway, confidence for the volume plan and the leader's own currency exposure for the Norwegian risk. Ruddiman's current prices are too low for the demand it faces, and raising them earns more than selling more.

References

Bresnahan, T. F., & Reiss, P. C. (1991). Entry and competition in concentrated markets. Journal of Political Economy, 99(5), 977-1009. https://doi.org/10.1086/261786

Lerner, A. P. (1934). The concept of monopoly and the measurement of monopoly power. The Review of Economic Studies, 1(3), 157-175. https://doi.org/10.2307/2967480

Working, E. J. (1927). What do statistical "demand curves" show? The Quarterly Journal of Economics, 41(2), 212-235. https://doi.org/10.2307/1883501