Economics: The Cost of Production

Please complete Questions For Review # 2,4,5 and Problems and Applications # 3,4,6. Complete for tomorrow by 2:00pm.

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A firm’s total costs can be divided between fixed
costs and variable costs. Fixed costs are costs that
do not change when the firm alters the quantity
of output produced. Variable costs are costs that
change when the firm alters the quantity of out-
put produced.

From a firm’s total cost, two related’measures of
cost are derived. Average total cost is total cost
divided by the quantity of output. Marginal cost
is the amount by which total cost rises if output
increases J?y 1 unit.

When analyzing firm behavior, it is often useful
to graph average total cost and marginal cost. For

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CHAPTER 13 THE COSTS OF PRODUCTION 275

a typical firm, marginal cost rises with the quan-
tity of output. Average total cost first falls as out-
put increases and then rises as output increases
further. The marginal-cost curve always crosses
the average~total-cost curve at the minimum of
average total cost. ·

A firm’s costs often depend on the time horizon
considered. In particular, many costs are fixed in
the short run but variable in the long run. As a
result, when the firm changes its level of produc-
tion, average total cost may rise more in the short
run than in the long run.

total revenue, p. 260
total cost, p. 260
profit, p. 260

production function, p. 263
marginal product, p. 264
diminishing marginal

average fixed cost, p. 268
average variable cost, p. 268
marginalcostp.268

product, p. 265 explicit costs, p. 261
implicit costs, p. 261
economic profit, p. 262
accounting profit, p. 262

fixed costs, p. 266
variable costs, p. 266
average total cost, p. 267

efficient scale, p. 270
economies of scale, p. 272
diseconomies of scale, p. 272
constant returns to scale, p. 273

1. What is the relationship between a firm’s total
revenue, profit, and total cost?

2. Give an example of an opportunity cost that
an accountant might not count as a cost. Why
would the accountant ignore. this cost?

3. What is marginal product, and what does it
mean if it is diminishing?

4. Draw a production function that exhibits
diminishing marginal product of labor. Draw
the associated total-cost curve. (In both cases, be
sure to label the axes.) Explain the shapes of the
two curves you have drawn.

1. This chapter discusses many types of costs:
opportunity cost, total cost, fixed cost, variable
cost, average total cost, and marginal cost. Fill in
the type of cost that best completes each sentence:
a. What you give up for taking some action is

called the __ _
b. __ is falling when marginal cost is below

it and rising when marginal cost is above it.

5. Define total cost, average total cost, and marginal
cost. How are they related?

6. Draw the marginal-cost and average-total-cost
curves for a typical firm. Explain why the
curves have the shapes that they do and why
they cross where they do.

7. How and why does a firm’s average-total-cost
curve differ in the short run and in the long
run?

8. Define economies of scale and explain why they
might arise. Define diseconomies of scale and
explain why they might arise.

c. A cost that does not depend on the quantity
produced is a(n) ___ .

d. In the ice-cream industry in the short run,
___ includes the cost of cream and sugar
but not the cost of the factory.

e. Profits equal total revenue less __ _
f. The cost of producing an extra unit of output

is the __ _

PARTY FIRM BEHAVIOR AND THE ORGANIZATION OF INDUSTRY

2. Your aunt is thinking about opening a
hardware store. She estimates that it would
cost $500,000 per year to rent the location and
buy the stock. In addition, she would have to
quit her $50,000 per year job as an accountant.
a. Define opportunity cost.
b. What is your aunt’s opportunity cost of

running a hardware store for a year? If your
aunt thought she could sell $510,000 worth
of merchandise in a year, should she open
the store? Explain.

3. A commercial fisherman notices the following
relationship between hours spent fishing and
the quantity of fish caught:

Hours

0 hours
1
2
3
4
5

Quantity of Fish
(in pounds)

0 lb.
10
18
24
28
30

a. What is the marginal product of each hour
spent fishing? ·

b. Use these data to graph the fisherman’s
production function. Explain its shape.

c. The fisherman has a fixed cost of $10 (his
pole). The opportunity cost of his time is $5
per hour. Graph the fisherman’s total-cost
curve. Explain its shape.

4. Nimbus, Inc., makes brooms and then sells
them door-to-door. Here is the relationship
between the number of workers and Nimbus’s
output in a given day:

Average
Marginal Total Total Marginal

Workers Output Product Cost Cost Cost

0 0

20

2 50

3 90

4 120

5 140

6 150

7 155

a. Fill in the column of marginal products.
Whaf pattern do you see? How might you
explain it?

b. A worker costs $100 a day, and the firm has
fixed costs of $200. Use this information to
fill in the column for total cost.

c. Fill in the column for average total cost.
(Recall that ATC = TC/Q.) What pattern do
you see?

d. Now fill in the column for marginal cost.
(Recall that MC = 11TC/ 11Q.) What pattern
you see?

e. Compare the column for marginal product
·and the column for marginal cost. Explain
the relationship.

f. Compare the column for average total cost
and the column for marginal cost. Explain
the relationship.

5. You are the chief financial officer for a firm that
sells digital music players. Your firm has the
following average-total-cost schedule:

Quantity

600 players
601

Average Total Cost

$300
301

Your current level of production is 600 devices,
all 9f which have been sold. Someone calls,
desperate to buy one of your music players.
The caller offers you $550 for it. Should you
accept the offer? Why or why not?

6. Consider the following cost information for a
pizzeria:

Quantity Total Cost Variable Cost

0 dozen pizzas $300 $ 0
1 350 50
2 390 90
3 420 120
4 450 150
5 490 190
6 540 240

a. What is the pizzeria’s fixed cost?
b. Construct a table in which you calculate

the marginal cost per dozen pizzas
using the information on total cost. Also,
calculate the marginal cost per dozen
pizzas using the information on variable
cost. What is the relationship between
these sets of numbers? Comment.