Salvador grows orchids to sell to local florists. When Salvador began raising his current crop of 1,000 orchids, he could sell them for $20 per plant, and he incurred shipping costs of $3 per plant. His cost of raising orchids is $8 per plant

Question

When his crop was ready to ship, florists were only paying $9 per plant. Use marginal analysis to determine Salvador's best course of action given the drop in the price of orchids.

Answer 1

When Salvador began raising his current crop of orchids, he expected to earn revenue of $20,000 and incur costs of $8,000 for raising the plants and an additional $3,000 for shipping, leaving him with a net (marginal) benefit of $9,000. With the drop in price, his revenue will be $9,000 and his costs will be $11,000, leaving him with a loss of $2,000. Although it may seem as though the best option for Salvador is to not sell his orchids at this lower price, the $8,000 cost of raising the orchids has already been incurred, so if he chooses to not sell the orchids, he will lose $8,000. If he chooses to sell his orchids, his net loss will only be $2,000. So by selling the orchids, Salvador's marginal benefit is $9,000 and his marginal cost is the $3,000 shipping expense. His best course of action is to sell the orchids, even at the lower price.