Example 7-4

Wholesale price
Selling price
Salvage value
Production cost
Average demand

: $80/unit
: $125/unit
: $20/unit
: $35/unit
: 78,000/6 = 13,000

Manufacturer marginal profit

Retailer marginal profit
Marginal cost

= $80 - $35 = $45

= $125 - $80 = $45
= $35 - $20 = $15

Marginal profit > marginal cost

So, quantity should be more than average demand, which is more than 13,000.
Decentralized System --- retailers individually orders to manufacturer.
Assumed, optimal order quantity = 12,000 units
Manufacturer
Expected manufacturer profit
= $125(12,000) $35(12,000)
= $540,000 (from each retailer)
Total expected manufacturer profit = $540,000 x 2 = $1,080,000
Retailer
Expected sales
= 11,340 units
Expected retailer profit
= $125(11,340) + $20 (12,000 11,340) - $80(12,000)
= $470,700 (from each retailer)
Total retailer expected profit = $470,700 x 2 = $941,400
Assumed, optimal order quantity = 13,900 units
Manufacturer
Expected manufacturer profit
= $125(13,900) $35(13,900)
= $625,500 (from each retailer)
Total expected manufacturer profit = $625,500 x 2 = $1,251,000
Retailer
Expected sales
= 12,604 units
Expected retailer profit
= $125(12,504) + $20 (13,900 12,604) - $80(13,900)
= $489,420 (from each retailer)
Total retailer expected profit = $489,420 x 2 = $978,840

Centralized system --- retailers operate joint venture facility and takes the items
out.
Manufacturer
Optimal order quantity
= 26,000 units
Expected manufacturer profit
= $125(26,000) $35(26,000)
= $1,170,000

Retailer
Expected sales
Expected profit

= 24,470 units
= $125(24,470) + $20 (26,000 24,470) - $80(26,000)
= $1,009,350