For the past three years, Rhetorix, Inc. has produced the model X100 stereo speaker. The model is in high demand, and the company can sell as many pairs as it can produce. The selling price per pair is $900.Variable costs of production are $300, and fixed costs per year are $720,000.Each pair of speakers requires 5 hours of assembly time. Currently the company has 5 assembly workers who are highly skilled and can work a total of 12,500 hours per year. With a tight labor market, the company finds it difficult to hire additional assembly workers with the skill needed to assemble the X100. Jurgis Rand, the owner of Rhetorix, is considering offering assembly workers an overtime premium (wages in excess of regular hourly wages) to get them to work more than 12,500 hours per year. In thinking about how much to offer, Jurgis performed the following calculation:
Sales (2,500 units x $900)........... $2,250,000
Less variable costs (2,500 x $300) ...... 750,000
Less fixed costs............... 720,000
Profit................... $ 780,000
Profit/assembly hours $62.40 per assembly hour
After seeing this calculation, Jurgis decided to offer an overtime premium of $31.20 per hour to his assembly workers. Jurgis reasoned: “This is a great deal. Both the workers and I make an extra $31.20 when they work an hour of overtime!”
a. How much would profit increase if 5 more assembly hours were available at the regular hourly wage for assembly workers?
b. Compare your answer in part a to the answer that Jurgis would provide to the question in part a (i.e., $78 x 5 = $390).What is the flaw in Jurgis’s calculation of the value of additional assembly time?
c. Suppose Jurgis pays assembly workers $31.20 per hour of overtime premium. On average, what will be the incremental benefit to Jurgis of an hour of extra assembly time?