The following income statements illustrate different cost structures for two competing companies:

Income Statements
Kent Trent
Number of Customers (a) 88 88
Sales revenue (a x $250) $22,000 $22,000
Variable cost (a x $180) N/A $(15,840
Variable cost (a x $0) 0 N/A
Contribution margin 22,000 6,160
Fixed cost $(15,840) 0
Net income $6,160 $6,160
(a) Reconstruct Kent's income statement, assuming that it serves 176 customer when it lures 88 customers away from Trent by lowering the sales price to $150 per customer.

(b) Reconstruct Trent's income statement, assuming that it serves 176 customers when it lures 88 customer away fro Kent by lowering the sales price to $150 per customer.

Kent net income is $10,560.00

Trent net loss is -$5,280.00  

Explanation:

It would be more appropriate to show the reconstructed income statements for both companies using spreadsheet.

The point is that Trent variable cost per unit is $180  and by lowering price per unit to $150 in order to lure away customers from Kent,Trent would incur losses as found in the revised income statements attached.

Please read explanation whilst referring to the attached table :)

Explanation:

1. Absolute Advantage

Absolute advantage is the ability of an individual, company, region or country to produce a greater quantity of a good or service than another individual, company, region or country using the same resources.

Cake: Sarah

Bread: Sarah

Sarah takes the least time to produce both a loaf of bread as well as a cake when compared to Kate. In the time Kate takes to produce one cake, Sarah can produce 2 cakes (60 mins / 30 mins). In the time it takes Kate to produce one loaf of bread, Sarah can produce 3 loaves (120 mins / 40 mins).

2. Kate's opportunity cost of producing one cake

Opportunity cost is the benefit lost from the second best alternative. In this case, the number of loaves of bread Kate sacrifices to produce 1 cake. It takes 60 mins for her to produce a cake whilst it takes 120 mins to produce a loaf of bread. Hence opportunity cost of producing one cake = 60 / 120 = 1/2 a loaf of bread. This means that when she is producing a cake, she is using up the time that she can use to produce half a loaf of bread.

3. Sarah's opportunity cost of producing one cake

The second best alternative to Sarah to cake production, is the production of bread. It takes 30 mins for her to produce a cake whilst it takes 40 mins for her to produce a loaf of bread.  Hence opportunity cost of producing one cake = 30 / 40 = 3/4 a loaf of bread. In other words, in the time that Sarah spends producing a cake, she is actually able to accomplish three-quarters of a loaf of bread production.

4. Comparative Advantage

Comparative advantage is referred to as an individual, company, region or country's ability to produce goods and services at a lower opportunity cost than that of its trade partners. The person with the least opportunity cost has comparative advantage in that product.

Cake: Kate

As per the above calculations, Kate only loses making 1/2 a loaf of bread whilst Sarah loses making 3/4 of a loaf of bread.

Bread: Sarah (explanation below)

Kate = 120 / 60 = 2 cakes sacrificed

Sarah = 40 / 30 = 1.3 cakes sacrificed

Hence, Sarah has comparative advantage in the production of a loaf of bread as she has to sacrifice producing only 1.3 cakes whilst Kate sacrifices producing 2 cakes in the time taken to produce a loaf of bread.