Topic:
The following appeared as part of an annual report sent to stockholders by Olympic Foods, a processor of frozen
foods:
"Over time, the costs of processing go down because as organizations learn how to do things better, they become
more efficient. In color film processing, for example, the cost of a 3-by-5-inch print fell from 50 cents for five-day
service in 1970 to 20 cents for one-day service in 1984. The same principle applies to the processing of food. And
since Olympic Foods will soon celebrate its 25th birthday, we can expect that our long experience will enable us to
minimize costs and thus maximize profits."
Discuss how well reasoned . . . etc.
Response:
The writer of Olympic Foods' annual report concludes that their company, which processes frozen foods, will earn higher profits on account of lower processing-costs resulting from efficiency caused by long experience. He bases this conclusion on the reduction in film-processing costs over a specific time-span. The writer, however, fails to investigate certain assumptions that he has made while arriving at his conclusion.
Most importantly, the writer of the report has assumed that the decrease in film-processing costs has resulted from film-processing companies learning how do do things better. No other reasons for the drop in costs are explored. It is possible that the cost of raw-materials required to process films dropped by a large margin between 1970 and 1984. In such a scenario, a better performance in their core tasks cannot be stated as the reason for the decreased costs.
The writer also assumes that a reduction in film-processing costs translates into a reduction in costs in the food-processing industry as well. This line of reasoning is weak, as it ignores any factors that might have gone into cost-reduction for the film-processing industry only. For example, the lower costs may be explained by a drop in prices for chemicals required for photo-processing, or a sudden by surge in supply and a resulting price-drop for photo-paper. In such a case, a company should not conclude that they, too would see cost-reductions merely due to their long existence.
Another assumption that the writer makes is that a decrease in costs would always mean an increase in profits. The writer has ignored the other side of the equation, that is revenues. If over a long period of time, Olympic Foods' revenues dwindle faster than the amount that the company spends on food-processing, it's profits will go down instead of going up. Thus, stating that a decrease in costs would enable the company to maximise its profits ignores a basic, yet vital aspect of economic theory, and might not hold good.
In order to verify whether the company's conclusion regarding cost-lowering resulting from experience is strong, it should investigate whether the reasons for cost-drops for the film-processing industry were indeed from better methods learned from experience. Also, the company should find out whether the reasons for film-processing cost decreases were across industries or were limited to that specific industry only. Finally, Olympic Foods should calculate its profit margins based on past and expected future revenues. Only if the company finds the answers to these vital questions in line with the evidence that they have stated, should they conclude that they will see a reduction in costs and a parallel increase in profits.
The following appeared as part of an annual report sent to stockholders by Olympic Foods, a processor of frozen
foods:
"Over time, the costs of processing go down because as organizations learn how to do things better, they become
more efficient. In color film processing, for example, the cost of a 3-by-5-inch print fell from 50 cents for five-day
service in 1970 to 20 cents for one-day service in 1984. The same principle applies to the processing of food. And
since Olympic Foods will soon celebrate its 25th birthday, we can expect that our long experience will enable us to
minimize costs and thus maximize profits."
Discuss how well reasoned . . . etc.
Response:
The writer of Olympic Foods' annual report concludes that their company, which processes frozen foods, will earn higher profits on account of lower processing-costs resulting from efficiency caused by long experience. He bases this conclusion on the reduction in film-processing costs over a specific time-span. The writer, however, fails to investigate certain assumptions that he has made while arriving at his conclusion.
Most importantly, the writer of the report has assumed that the decrease in film-processing costs has resulted from film-processing companies learning how do do things better. No other reasons for the drop in costs are explored. It is possible that the cost of raw-materials required to process films dropped by a large margin between 1970 and 1984. In such a scenario, a better performance in their core tasks cannot be stated as the reason for the decreased costs.
The writer also assumes that a reduction in film-processing costs translates into a reduction in costs in the food-processing industry as well. This line of reasoning is weak, as it ignores any factors that might have gone into cost-reduction for the film-processing industry only. For example, the lower costs may be explained by a drop in prices for chemicals required for photo-processing, or a sudden by surge in supply and a resulting price-drop for photo-paper. In such a case, a company should not conclude that they, too would see cost-reductions merely due to their long existence.
Another assumption that the writer makes is that a decrease in costs would always mean an increase in profits. The writer has ignored the other side of the equation, that is revenues. If over a long period of time, Olympic Foods' revenues dwindle faster than the amount that the company spends on food-processing, it's profits will go down instead of going up. Thus, stating that a decrease in costs would enable the company to maximise its profits ignores a basic, yet vital aspect of economic theory, and might not hold good.
In order to verify whether the company's conclusion regarding cost-lowering resulting from experience is strong, it should investigate whether the reasons for cost-drops for the film-processing industry were indeed from better methods learned from experience. Also, the company should find out whether the reasons for film-processing cost decreases were across industries or were limited to that specific industry only. Finally, Olympic Foods should calculate its profit margins based on past and expected future revenues. Only if the company finds the answers to these vital questions in line with the evidence that they have stated, should they conclude that they will see a reduction in costs and a parallel increase in profits.
