Comments:

This is a question about whether costs increase along the cost line or because the line changes.

Problem statement:

I was recently looking at the relationship between auto manufacturers and suppliers. Manufacturers include

GM and Ford. Suppliers include UGN, a supplier of auto insulation products.

Suppliers typically do business with the car companies under fixed contracts that set per-unit prices for the

length of a vehicle program—which can run longer than five years—and are difficult to renegotiate,

executives and industry attorneys say. Inputs to the suppliers are have been difficult to get; the suppliers’

variable cost, like raw-material prices and labor costs, have soared. This squeezes the suppliers because the

suppliers continue to sell to the manufacturers under the fixed price contracts.

Auto production has been limited, resulting in limited autos for sale at high prices. GM and Ford have had

high profits. This pushes back on UGN, such that UGN has fewer sales and higher costs.

One of the three graphs, A, B, and C describes the change in cost to the suppliers because of the increased

raw-materials and labor costs.

Graph A: Variable cost per unit stays the same. Fixed cost remains the same. The cost increases when more

is purchased because the activity increases and cost decreases when less is purchased because the activity

decreases.

Graph B: Variable cost per unit increases. Fixed cost remains the same. The cost increases because, for any

amount purchased, the cost per unit is higher, shown as a steeper slope to the cost line.

Graph C: Variable cost per unit stays the same. Fixed cost increases. The cost increases because, for any

amount purchased, the fixed cost is higher, shown as a higher intercept for the cost line.

Required:

1. Which graph seems to represent the cost increase on the supplier? Explain your choice.

2. What is the impact on breakeven of the supplier from your choice of graph? Explain.

3. It seems that the manufacturers’ contracts with suppliers set the price, but do not set the quantity. As a

result, when the manufacturers are producing fewer autos, the manufacturers purchase fewer parts from

the suppliers. Does the reduction in the number of parts purchased affect the breakeven point, or does it

affect the distance between current production and the breakeven point?