Question

Your insurance firm processes claims, through its newer, larger, high-tech facility, and its older, smaller low-tech facility. Each month, the high-tech facility handles 10,000 claims, incurs $100,000 in fixed costs, and $100,000 in variable costs. Each month, the low-tech facility handles 2,000 claims, incurs $16,000 in fixed costs, and $24,000 in variable costs. If you anticipate a decrease in the number of claims, where will you lay off workers?

Answer 1

Answer:

The answer is:

Lay-off workers in "low-tech facility" i.e. $12 per claim.

Explanation:

Step 1:

The total fixed cost:

It is the cost, that the producer has to bear irrespective of the level of production.

Total variable cost:

It is the cost that alters with the changes with the changes in the production level.

Step 2:

The insurance firm has two facilities for claim process:

1: High-tech facility - new

2: Low-tech facility - old

High-tech facility:

Claims handled in a month = 10,000

Fixed costs = $100,000

Variable costs = $100,000

Low-tech facility:

Claims handled in a month = 2,000

Fixed costs = $16,000

Variable costs = $24,000

Step 3:

The fixed costs have to be borne, because they are unavoidable, but the variable costs can be ignored.

In high-tech facility, average variable cost per claim = $100,000/10,000 = $10 per claim

In low-tech facility, average variable cost per claim = $24,000/2,000 = $12 per claim

Step 4:

Conclusion:

If there is a decrease in the number of claims, the workers should be laid-off in low-tech facility, because variable cost per claim is higher in low-tech facility i.e. $12 per claim.

This will help in reducing the costs.