Worked Problem: Production Challenges for Tesla: The Model S
Tesla Motors, founded in 2003, exclusively produces electric cars and electric powertrains in a former Toyota factory in Fremont, California. The Tesla Roadster, a sports car, was the company’s first design. Their newest design, available for 2012 delivery, is the Tesla Model S, a luxury sedan. The Model S uses no gasoline, has a range of up to 300 miles per charge, and has zero tailpipe emissions. Although demand for the car has been strong, production of the Model S at the Fremont plant is currently less than Tesla had anticipated.
Let’s assume that Tesla engineers knew they needed to either build or buy a new factory in order to produce the new Model S. 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.
| Total cost (hundreds of millions of U.S. dollars) | |||
|---|---|---|---|
| Plant size | 10,000 cars sold | 20,000 cars sold | 30,000 cars sold |
| A | $1.75 | $3.25 | $5.5 |
| B | 2.0 | 3.0 | 5.0 |
| C | 2.5 | 4.0 | 4.5 |
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 sales would be only 20,000 vehicles per year. But, by 2012, 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 per car at a size C plant if only 20,000 cars are built. At a size C plant, what is the average total cost of production if only 10,000 cars are built?
Find Tesla’s total cost at this plant when producing 20,000 cars and when producing 10,000 cars.
Review the section “Short-Run versus Long-Run Costs” on pages 197–201. Compare Tesla’s decision to the decision faced by Selena’s Gourmet Salsas in Figure 6-11. By deciding to build a size C plant, Tesla has chosen the high fixed-cost, low variable-cost solution.
With production of 20,000 cars, the company’s total cost of production is $400,000,000. When it falls to 10,000 cars, total production cost is $250,000,000. 
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.
Again, review the section “Short-Run versus Long-Run Costs,” and especially the paragraphs discussing the long-run average total cost curve.
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.
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Find Tesla’s average total cost of production at the various plant sizes and production levels.
Review the section “Average Total Cost” and especially Table 6-2 [on pages 191–194].
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 the following table.
| Average Total Cost | |||
|---|---|---|---|
| Plant size | 10,000 cars sold | 20,000 cars sold | 30,000 cars sold |
| A | $17,500 | $16,250 | $18,333 |
| B | $20,000 | $15,000 | $16,667 |
| C | $25,000 | $20,000 | $15,000 |