You are a newspaper publisher. You are in the middle of a one-year rental contract for your factory that requires you to pay $600,000 per month, and you have contractual labor obligations of $1,250,000 per month that you can't get out of. You also have a marginal printing cost of $0.25 per paper as well as a marginal delivery cost of $0.1 per paper. If sales fall by 20 percent from 1,000,000 papers per month to 800,000 papers per month, what happens to the Average Fixed Costs per paper?

If sales fall by 20 percent from 1,000,000 papers per month to 800,000 papers per month, Average Fixed Costs will increase from $1.85 per paper to $2.31 per paper.

Explanation:

The fixed costs mentioned add up to 600,000 + 1,250,000 = $1,850,000 per month

The other costs mentioned (printing cost and delivery cost) are variable with output (per paper).

As fixed costs are the same regardless of output, falling sales will reduce the quantity on which fixed cost are spread (to calculate fixed cost) and thus make average fixed cost increases.

In this case, it increases from 1,850,000/1,000,000 ( = $1.85 per paper) to 1,850,000/800,000 ( = $2.31 per paper)