Production and Costs

1. Suppose that you and a friend have started a pizza delivery business and you call it 'Pizza Pronto'. First, you had to find a shop front to make the pizzas and this costs $35,000 per year plus set up costs of $55,000 for the oven and kitchen set up. Employing one person, you estimate you could make and deliver 40 pizzas per hour, but employing a second person this increases to 60 pizzas per hour. The hourly cost of labour is $50 per person; the costs of ingredients for making a pizza is around $3 each and delivery is around $2 per pizza. In starting the business you would have to give up your job as an accountant.

a) Calculate the fixed costs of this business. What are the implicit costs of the business if using your combined savings to start up?

b) What is the marginal product of the second worker?

c) If you make and deliver 60 pizzas per hour calculate the average variable cost of a single pizza. )

Elasticity

2. You find a new way to organise the business that reduces the cost of delivering a pizza. You believe this will enable the business the reduce the price of pizza from $12 to $10. This is expected to lead to an increase in pizzas delivered from 800 per week to 1200 per week.

a) Use the mid-point method to calculate the price elasticity of demand. Is this elastic or inelastic?

b) What will happen to total revenue if the price of pizza is decreased? What should you do?