Midterm 2 Make vs Buy

Consider the following three production technologies.

Technology A Has a fixed cost of $5.00 and an average variable cost of $3.00.

Technology B Has a fixed cost of $10.00 and an average variable cost of $2.00.

Technology C Has a fixed cost of $40.00 and an average variable cost of $1.00.

In all cases assume that you can sell your output for $5.00.

Which technology would you use when your output level is 20?

(a) A
(b) B
(c) C
(d) A or C

First we want to set up a chart showing the total costs (fixed costs + average variable cost per unit) associated with each technology and the total benefits gained when producing 20 units at a cost of $5/unit.

Total Cost Total Benefits
Tech A 5 + 3(20) = $65 100 - 65 = $35
Tech B 10+ 2(20) = $50 100 - 50 = $50
Tech C 40 +1(20) = $60 100 - 60 = $40

We gain the most amount of benefits by using Technology B: $50
and so, the answer is (b).

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