Page 231 - DECO101_MICRO_ECONOMICS_ENGLISH

Micro Economics

Notes that will allow maximum profit from a limited supply of yarn. If he uses traditional pricing
systems, his decision will be based on the following (hypothetical) calculations:
Cost per metre Design A Design B
Yarn cost R 36 R 18.00
Other materials R 27 R 24.00
Labour and other variable costs R 15 R 12.00
Total variable costs R 78 R 54.00
Total fixed costs R 12 R 10.50

Total costs R 90 R 64.50
Selling price per metre R108 R 77.40

Profit per metre R 18 R 12.90

Obviously, it appears that Design A is more profitable than Design B. However, a costing
that is based on variable costs and contributions produces a different result.
Per metre Design A Design B
Selling price R108 R77.40
Total variable costs R78 R54.00
Contribution per mtr. R30 R23.40
Of course, we have not yet taken into account the “restraining factor” – in this case, the
yarn supply and the fact that Design B uses half the raw material needed to make Design
A. To get a more accurate picture, we make a calculation based on the fact that, with the
yarn available, Design B allows twice as much fabric to be manufactured.
Design A Design B
Product in metres (say) 5,000 10,000
Contribution per metre R30 R23.40
Total contribution R 1.5 lakh R 2.34 lakh
The emphasis should, therefore, be on marketing Design B.
Indeed, a more important advantage of this route is that it allows the marketer to make any
price adjustment dictated by the market whilst knowing precisely what effect it will have
on his profi ts!
Let us assume a competitor offers a product similar to the fabric B used in the example, at
a price of R 75. According to the traditional costing method, design A apparently becomes

even more profitable to produce.
But, again, the “restraining factor” – let us say, limited yarn supply in this case – combined
with the contribution approach, reveals a different situation although the price of Design B
is reduced by, say, R 2.40 per metre.

Design A Design B
Metre Produced (say) 5,000 10,000
Contribution per metre R 30 R 21
Total contribution R 1.5 lakh R 2.1 lakh

Product B can still produce extra profits over Product A, even at the lower price made
necessary to match the price of competition.

Contd...

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