Tesla Motors, founded in 2003, produces electric cars in a former Toyota factory in Fremont, California. The Tesla Roadster, a sports car, was the company’s first design. Their latest design, the Tesla Model X, hit the road in 2015. The Model X is an all-wheel-drive, full-size luxury, crossover SUV. It uses no gasoline, has a range of 250 miles per charge, and has zero tailpipe emissions. It is considered to be the safest and fastest SUV ever developed.

Pre-orders for the Model X exceeded 30,000 units, nearly triple those for the previous model, the 2012 Tesla Model S. Despite the strong demand, production of the Model X at the Fremont plant was slower than expected.

Let’s assume that Tesla engineers knew they needed to either build or buy a new factory in order to produce the new Model X. And, suppose that Tesla engineers and accountants estimated the following hypothetical cost structure per year based on full-year production at plants of different sizes.

When Toyotas were built there, the Fremont plant produced about 80,000 vehicles per year. Suppose that Tesla equipped the plant with the hopes of producing 30,000 Tesla vehicles per year, yet in its first few years of production, Tesla predicted production would be only 20,000 vehicles per year. But, by 2015, because of production delays, actual sales dropped to less than 10,000 cars per year. Using the table, find Tesla’s average total cost of production across the various plants for each level of production. Explain why the production costs with size C plant are higher than they would be if Tesla could build a new plant that was equipped to produce 10,000 vehicles.

STEP | 1 Find Tesla’s average total cost of production at the various plant sizes and production levels.Review pages 185–188.

Average total cost is found by dividing total cost by the quantity of output. So, if Tesla has a total cost of $175,000,000 at an output of 10,000 cars we calculate $175,000,000/10,000 = $17,500. Average total cost for each plant size and production level from the previous table are given in this following table.

STEP | 2 Explain why the production cost with a size C plant is higher than it would be if Tesla could build a new plant that was best equipped to produce 10,000 vehicles.Review pages 191–194.

If Tesla were to build a new plant based on production of 10,000 vehicles, it would build a size A plant. Tesla would be able to adjust its fixed cost to a new level that minimizes average total cost for its new output level. If Tesla could easily change its plant size, it would always build the plant size that minimizes its average total cost on its long-run average total cost curve. However, if the size of the plant is fixed at size C, then it will be on its short-run average total cost curve based on a size C plant.