Compare expected benefits and costs against a feasible alternative.
A supported expansion decision connects the objective, relevant cost and revenue changes, capacity and uncertainty. Lower average cost can help profit, but the firm must sell the output and cover the relevant costs of expanding. Distinguish a larger total profit from a higher profit margin, meaning profit as a percentage of revenue, and assess a consistent period. Weigh the most important conditions rather than ending with a list of possible advantages and disadvantages. The later strategies chapter considers competition, shutdown and exit in greater detail; a loss or a sunk payment alone does not settle those decisions.
- Revenue forecast
- Capacity must be matched by sales at a viable price.
- Cost comparison
- Include relevant opportunity costs for the same period.
- Decision condition
- State the sales/cost threshold that would change the choice.
Apply the distinction
No guarantee
Lower unit cost or more output alone does not establish a higher profit.
Later scope
Shutdown, exit, detailed competition and pricing strategies are developed in the next firm-strategies chapter.
Worked example: How many sales justify the expansion?
A producer sells 100 units at $25 each with total relevant cost $2,000 per month. An expansion could supply and sell 200 units at $20 each with cost $3,000. If demand disappoints, it would sell only 150 at $20 while committed monthly cost remains $3,000. These costs include all relevant opportunity costs for the stated comparison.
- Currently TR is $2,500 and profit $500. Under the full-sales forecast, TR is $4,000 and profit $1,000.
- The forecast unit cost falls from $20 to $15, but the profit gain still depends on the stated sales and price assumptions.
- At 150 sales with the specified $3,000 cost, revenue is $3,000 and economic profit zero, below the current $500. Capacity is not a guarantee of demand.
- At a $20 price and unchanged $3,000 cost, match the current $500 profit: 20Q-3000=500, so 20Q=3500 and Q=175. More than 175 sales are needed to improve on it. Proceed only if evidence supports sufficient sales and the commitment is affordable.
Watch out for this
Lower average cost alone proves an expansion is best.
Combine the cost comparison with feasible sales, prices, the objective and the risks of committed resources.
Check your understanding
In this expansion case, 175 units sell at $20 and total cost is $3,000. How does profit compare with the current $500?
- It is equal: 175 x 20 - 3000 = 500.
- It is higher because the firm is larger.
- It is zero because costs are high.