# 4 . Individual Problems 22-1 Suppose that a paper mill “feeds” a downstream box mill. For the downstream mill, the marginal profitability of producing boxes declines with volume. For example, the firs

4 . Individual Problems 22-1

Suppose that a paper mill “feeds” a downstream box mill. For the downstream mill, the marginal profitability of producing boxes declines with volume. For example, the first unit of boxes increases earnings by \$10, the second by \$9, the third by \$8, and so on, until the tenth unit increases profit by just \$1.

The cost the upstream mill incurs for producing enough paper (one “unit” of paper) to make one unit of boxes is \$3.50.

Assume the two mills operate as separate profit centers, and the paper mill sets the price of paper. It follows that the marginal profitability of boxes represents the highest price that the box division would be willing to pay the paper division for boxes.. Furthermore, assume that fixed costs are \$0 for the paper mill.

The following table summarizes the quantity, total revenue, and marginal costs from the perspective of the paper mill for selling paper to the box mill at various prices.

In the following table, fill in the marginal revenue, total cost, and total profit for the paper mill when selling paper to the box mill at each given price.

Price                      Quantity         Total Revenue          Marginal revenue         Total Cost       Marginal Cost        Profit

(Marginal Profitability to the Box Mill)

(Units of Paper equivalent to One Box)

(\$)                                                             (\$)                         (\$)                                    (\$)                         (\$)                    (\$)

FIll In Th Chart

\$10                               1                         \$10                                                              \$3.50                                        ___?___

\$9                                  2                         \$18                  _____?___                           ____?___          \$3.50                 ___?___

\$8                                  3                          \$24                 ___?___                               _?______          \$3.50                ___?___

\$7                                4                          \$28                 ___?___                                ___?___             \$3.50              ___?___

\$6                                 5                         \$30                    ___?___                           ___?_____          \$3.50                 ___?___

\$5                                  6                        \$30                   ___?___                           ___?_____          \$3.50                 ___?___

\$4                                  7                         \$28                    ___?___                           ___?_____          \$3.50                 ___?___

\$3                                   8                       \$24                       ___?___                           ___?_____          \$3.50                 ___?___

\$2                                  9                         \$18                    ___?___                           ___?_____          \$3.50                 ___?___

\$1                                 10                         \$10                     ___?___                           ___?_____          \$3.50                 ___?___

If the paper mill sets the price of paper to sell to the box mill, it will set a price of  ___?___  and sell  ___?___  units of paper to the box mill. Profits will be___?___ for the paper mill. Companywide  profits will be____?___. (Hint: Recall that the prices in the table represent the marginal profitability of each unit of paper, or box, to the box mill.)

Suppose the paper mill is forced to transfer paper to the box mill at marginal cost (\$3.50).

In this case, the box mill will demand  ___?___  units of paper. This leads to companywide profits of___?___