Mbeya cement company, which has a rising short-run marginal cost curve is currently
operating at a loss. Mbeya cement company's chief economist says that if the price rises a
little, the output should not be increased because, if its marginal cost would rise and the
company would end up with a bigger loss on a higher volume. Should the chief executive
officer of Mbeya cement company listen to the chief economist? Why or why not
NB: Your explanations should be supposed with a graph for more detail.
To answer this question, we need to understand the concept of marginal cost and its relationship with the firm's profit.
Marginal cost (MC) is the additional cost incurred by a firm to produce one more unit of output. It is calculated by dividing the change in total cost by the change in quantity produced. In the short run, a firm's marginal cost curve typically rises as output increases due to diminishing returns.
Let's analyze the situation using a graph:
1. Draw the quantity (Q) on the x-axis and the marginal cost (MC) on the y-axis.
2. Plot a rising marginal cost curve. As output increases, marginal cost increases due to diminishing returns.
Now, let's consider the options:
Option 1: Increase the price and maintain the same output level.
If the firm increases the price without increasing the output, the total revenue per unit sold will increase. However, the firm will still incur losses because the additional revenue will not be enough to cover the increasing marginal cost. This scenario can be depicted on the graph by drawing a horizontal line at the current output level (Q0) and moving it upwards to a higher price level (P1).
Option 2: Increase both the price and the output level.
If the firm increases both the price and the output, the total revenue will increase further. However, as mentioned earlier, the firm's marginal cost is rising. If the marginal cost of producing additional units exceeds the additional revenue generated from selling those units, the firm's losses will increase even more. This scenario can be depicted on the graph by increasing both the output level (Q1) and the corresponding marginal cost (MC1) from the current levels.
Given this analysis, the chief economist is advising against increasing the output level even if the price rises. This advice is supported by the fact that the firm is currently operating at a loss, and increasing the output could lead to even larger losses. The CEO should listen to the chief economist and prioritize cost management over increasing output in the short run.
The decision ultimately depends on the specific circumstances and goals of the firm. However, based on the chief economist's argument and the analysis of the rising marginal cost curve, it seems prudent to focus on reducing costs and improving efficiency before considering expanding the output level.