Shadow Cost - MCQ Test

A shadow price associated with a resource tells you how much more profit you would get by increasing the amount of that resource by one unit. An easy way to think about it is ……. Well how much you would be willing to pay for an additional resource? For example A company uses linear programming to decide on the production and sales budget that will maximise total contribution and profit for a financial period. The optimal solution involves using all available direct labour hours, for which the shadow price is $4.50 per hour, and machine hours, for which the shadow price is $3 per machine hour. Direct labour is paid $8 per hour. If the objective of the company is to maximise total contribution and profit in each period, how much should the company be willing to pay per hour to obtain additional direct labour hours of production capacity? A .Up to but not including $4.5 B. Up to but not including $9.5 C. Up to but not including $12.5 ******This means that the company would increase contribution by paying up to $(8 + 4.50) = $12.50 see below for an explanation D. Up to but not including $15.5 If they could buy one extra hour at the ‘normal’ price of $8 then we would make the ‘normal’ contribution which would mean an extra $4.50. But given that extra hours will cost more than $8 per hour (otherwise the hours would not be limited), for each extra $1 they cost the extra contribution will be reduced by $1. If the extra cost was $4.50 per hour then the extra contribution would be $0 and so the most extra they will be prepared to pay above the normal cost is $4.50.