I understand the math, but I am not sure about the effect of capacity on pricing decisions? That's what I need help on as I have already done the math part I just need the explanation of the last part.

The Scottie Sweater Company produces sweaters under the "Scottie" label. The company buys raw wool and processes it into wool yarn from which the sweaters are woven. One spindle of wool yarn is required to produce one sweater. The costs and revenues associated with the sweaters are given below: Per Sweater Selling price $31.00 Cost to manufacture Raw materials: Buttons, thread, lining $ 2.00 Wool yarn 16.00 Total raw materials 18.00 Direct labor 5.80 Manufacturing overhead 8.70 32.50 Manufacturing profit (loss) $(1.50) Originally, all of the wool yarn was used to produce sweaters, but in recent years a market has developed for the wool yarn itself. The yarn is purchased by other companies for use in production of wool blankets and other wool products. Since the development of the market for the wool yarn, a continuing dispute has existed in the Scottie Sweater Company as to whether the yarn should be sold simply as yarn or processed into sweaters. Current cost and revenue data on the yarn are given below: Per Spindle of Yarn Selling price $21.00 Cost to manufacture Raw materials (raw woon $7.00 Direct labor 3.60 Manufacturing overhead 5.40 16.00 Manufacturing profit $5.00 The market for sweaters is temporarily depressed, due to unusually warm weather in the western states where the sweaters are sold. This has made it necessary for the company to discount the selling price of the sweaters from the normal $40 price. Since the market for wool yarn has remained strong, the dispute has again surfaced over whether the yarn should be sold outright rather than processed into sweaters. The sales manager thinks that the production of sweaters should be discontinued, she is upset about having to sell sweaters at a loss when the yarn could be sold for a profit. However, the production superintendent does not want to close down a large portion of the factory. He argues that the company is in the sweater business, not they business, and the company should focus on its core strength. All of the manufacturing overhead costs are fixed and would not be affected even if sweaters were discontinued. Page 607 Manufacturing overhead is assigned to products on the basis of 150% of direct labor cost Materials and direct labor costs are variable yarn Per Sweater $10.00 Added revenue ($30.00 - $20.00) Added costs: Buttons, thread, lining Direct labor Added contribution margin $2.00 5.80 7.80 $ 2.20 $ 28.8 Added contribution magrin $ 2.2 31 3) Lowest possible cost Present Sweater Selling Price $ if wool yarn is sold out right Contribution Selling Price Per Spindle Yarn $ $ 10.4 Variable Cost per Spindle Yarn $ 10.6 21 7 3.6$ 10.6 Variable cost of producing a spindle of yarn Raw Wool $ Direct Labor $ Added variable cost of producing a sweater Buttons Thread Lining $ Direct Labor $ Total variable cost Opportunity cost CM margin if yarn is sold outright Losest price for sweater 2 5.8 $ 7.8 $ 18.4 $ 10.4 $ 28.8 3. What is the lowest price that the company should accept for a sweater? Support your answer with appropriate computations and explain your reasoning, including effect of capacity on pricing decisions