Ch06.pdf

# Ch06.pdf - Chapter 6 Dealing with Excess Supply and Excess...

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1 Chapter 6 Dealing with Excess Supply and Excess Demand in the Short Term 2 Why do we care? We always have either too little demand or too much demand => need to figure out what to do in these situations

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2 3 Supply and Demand in the Short Term In the short term, we cannot adjust capacity resources (buildings, equipment, skilled staff) => capacity is fixed and non-controllable In the long term, we choose capacity based on expected future demand over many years * capacity = maximum activity level that can be sustained with the available capacity resources Demand changes frequently => temporary gaps between demand and supply of capacity excess demand : demand > supply excess supply/excess capacity : demand < supply 4 Temporary gaps between Demand and Supply excess demand excess supply (excess capacity) (supply)
3 5 Dealing with Excess Supply You have unused capacity. Find some profitable use for this capacity. 6 Example: Special Order You own a restaurant. Capacity is 100 dinners a day. The regular price is \$30 per dinner. Variable costs are \$10 per dinner. Fixed costs are \$500 per day. On Mondays, business is slow. You expect to sell only 40 dinners (i.e., a lot of unused capacity ) Special order: A charity wants to hold its fundraising dinner in your restaurant on Monday. They offer to pay \$15 per dinner for a total of 50 dinners. Should you take this special order?

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4 7 Special Order – Gross Approach Gross approach : compute revenue, costs, and profits by brute force for each scenario Profit is higher if you take the special order => you should take it status quo (40 regular dinners) special order (40 regular dinners + 50 special-order dinners) Revenue (\$30 per regular dinner, \$15 per special-order dinner) \$1,200 (=40*\$30) \$1,950 (=40*\$30+50*\$15) Variable costs (\$10 per dinner) \$400 (=40*\$10) \$900 (=40*\$10+50*\$10) Contribution margin \$800 \$1,050 Fixed costs \$500 \$500 Profit \$300 \$550 8 Special Order – Incremental Approach Another approach: compute incremental revenue, incremental costs, and incremental profit relative to the status quo.
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